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Amendment No. 1
SmartDisk Corporation
Delaware | 3577 | 65-0733580 | ||
(State or other jurisdiction of | (Primary Standard Industrial Classification | (I.R.S. Employer | ||
incorporation or organization) | Code Number) | Identification Number) |
3506 Mercantile Avenue
Michael S. Battaglia
Copies to:
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.
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PROSPECTUS
22,238,463 shares of Common Stock
SmartDisk Corporation is conducting a rights offering. We are distributing rights to purchase shares of our common stock to each person that owned shares of our common stock at the close of business on , 2003. During this rights offering, we may issue up to 22,238,463 shares of common stock. On December 24, 2002, Addison Fischer, the Chairman of our Board of Directors, and Phoenix House Investments, LP, an entity controlled by Mr. Fischer, purchased from us an aggregate of 2,552,364.8 shares of our Series A Redeemable Convertible Preferred Stock for gross proceeds of approximately $2.5 million. Each share of Series A Preferred is convertible into shares of common stock at an initial conversion price of $0.32 per share of common stock such that each share of Series A Preferred is initially convertible into 3.125 shares of common stock. We are offering the subscription rights to our current stockholders to permit them to invest in shares of our common stock at the same $0.32 per share price as afforded to Mr. Fischer and Phoenix House.
You will receive 1.25 non-transferable subscription rights for each share of common stock that you owned on , 2003. The subscription rights are exercisable beginning on the date of this prospectus and continuing until 5:00 p.m., Eastern Standard Time, on , 2003. Each subscription right entitles you to purchase one share of common stock at a purchase price of $0.32 per share payable in cash or by delivery of shares of Series A Preferred. If you exercise all of your subscription rights, you also may have the opportunity to purchase additional shares at the same purchase price.
There is no minimum number of rights that must be exercised in this rights offering, and all net proceeds will be made immediately available to us for the purposes set forth in this prospectus. We cannot assure you that any shares of common stock will be sold in this offering. We will not receive additional capital in the event that Mr. Fischer or Phoenix House exercise their subscription rights through the tender of shares of Series A Preferred held by them. Mr. Fischer and Phoenix House have the ability to purchase 7,976,140 shares of common stock in this rights offering through the tender of all of the shares of Series A Preferred.
The subscription rights may not be sold or transferred. The subscription rights will not be listed for trading on any stock exchange or trading market.
Our common stock is traded on the NASDAQ SmallCap Market under the symbol “SMDK.” On January 29, 2003, the last sale price of our common stock as reported on the NASDAQ SmallCap Market was $0.39 per share. Based on our failure to comply with the NASDAQ listing standards regarding minimum bid price and market capitalization, NASDAQ has initiated delisting procedures against us. See “Risk Factors — If our securities are removed from NASDAQ listing, you may have more difficulty purchasing and selling our common stock.”
See “Risk Factors,” beginning on page , for a discussion of certain risk factors that you should consider before exercising your rights to buy shares of our common stock.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.
The date of this prospectus is , 2003
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SUMMARY
The following provides a summary of material information about our company and this rights offering. You should also carefully review the detailed information and financial statements, including the notes thereto, appearing elsewhere in this prospectus. Unless otherwise indicated, all information in this prospectus assumes no exercise of any currently outstanding stock options or warrants.
Our Company
We develop, manufacture, and market a range of advanced consumer electronic products and software solutions that are designed to simplify the use of digital products. Our products help users transfer, store, manage, and share digital music, video, pictures, and data. Headquartered in the United States, with operations in Europe and Asia, we sell and support our products worldwide.
Our products include external portable hard disk drives and floppy disk drives for desktop and notebook computers, external CD read/write recorders, flash memory card readers, scanners and CD creation software. Our products generally are available for both Windows and Macintosh operating systems, allowing the original equipment manufacturers, or OEMs, and retailers that market our products to reach a large installed base of potential users. Our products are designed to offer the following principal benefits:
Design. We emphasize innovative product designs that are both attractive and that enhance usability. Our flash memory readers, for example, feature an upright, ergonomic design that allow users to insert and eject media with just one hand. Our FireFly and FireLite portable external hard disk drives feature aesthetically pleasing industrial designs.
Portability. We place a premium on features that allow users to carry and use our products in a variety of settings. These features include compact designs, no requirement for a power adapter and no requirement for installed software drivers. We also offer carry cases that protect our products and make them easier to transport.
Ease of Use. Our products are easy to use and install. Our personal storage systems address the storage needs of today’s consumers: portability, user friendliness, reliability and seamless integration with computer operating systems. These storage devices also offer our proprietary software that enhances the user’s experience, further differentiating our products from competitors’ offerings.
Our FlashPath floppy disk adapter and flash media readers allow the consumer to conveniently transfer digital content from a digital camera or other appliance to a personal computer by simply inserting the flash memory card in the reader and copying its contents to the computer. The interface standard supported by our flash media readers eliminates any driver software for most of today’s Windows and Macintosh operating systems. Unlike other products, our flash memory products do not rely upon a digital appliance’s power source to transfer digital data from a flash memory card to a computer. For example, our media readers are powered by the personal computer. This is important because digital appliances, such as digital cameras, consume significant amounts of power and require frequent battery replacement or recharging. Products that use traditional cable interfaces quickly drain power from digital appliances, making those competing products less attractive. Also, consumers find portable products much more convenient to use if those products don’t require batteries or A/C adapters.
Our software products allow users to compose slide or video shows, create CDs, and play them with or away from a computer, without the need to learn the world of media and optical formats.
Versatility. Our products can be used with a variety of different computer hardware and software. As a result, the same media reader that is used to transfer images from one digital camera to a Microsoft-based computer can be used to transfer images from another digital camera to an Apple computer. Similarly, the same media reader that is used to transfer images may also be used to transfer voice and other digital data from a variety of digital appliances that use the same flash memory card. Our personal storage systems are also compatible with both Windows and Macintosh operating systems.
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Compatibility.We offer storage devices that are compatible with different computer systems. We offer flash memory cards for all of the leading flash media card formats. Our software products support an extensive array of technical standards for audio, data, enhanced music and video formats for authoring to CDs.
Quality. We believe that we have a reputation in the industry for producing high quality products. We have invested substantial resources in our product development and test efforts to assure that our products work reliably across a broad range of configurations.
Strategy
Our strategy is to:
• | bring hardware products quickly to market with innovative solutions that emphasize modern design, portability and ease of use and that capitalize on our core competencies; | |
• | introduce and acquire innovative, complementary software products to create, manage and use digital content on computers that can be viewed or played on digital and/or non-digital appliances; and | |
• | leverage the distributor, retail and Internet channels of distribution and OEM partners we have established. |
Key elements of this strategy include:
• | capitalizing on technology expertise to expand our product offerings; | |
• | expanding customer and strategic industry relationships; and | |
• | promoting brand awareness of our products. |
Our executive offices are located at 3506 Mercantile Avenue, Naples, Florida 34104, and our telephone number is (239) 436-2500. Our website is http://www.smartdisk.com. The contents of our website are not part of this prospectus.
Questions and Answers About the Rights Offering
What is a Rights Offering? |
A rights offering is an opportunity for our stockholders to purchase additional shares of common stock at a fixed price and in an amount proportional to the stockholders’ existing interests. This rights offering enables our company to raise additional capital while enabling you to maintain your current percentage ownership in our company.
What is a Subscription Right? |
We are distributing to you, at no charge, 1.25 subscription rights for each share of common stock that you owned on , 2003. Your subscription rights will be aggregated for all of the shares that you owned on that date and then rounded down to the nearest whole number, so that you will not receive any fractional rights. Each subscription right entitles you to purchase one share of common stock for $0.32. The subscription price may be paid in cash or by delivery of shares of Series A Preferred, which will be valued at $1.00 per share. When you “exercise” a subscription right, you choose to purchase the common stock that the subscription right entitles you to purchase. You may exercise any or all of your subscription rights, or you may choose not to exercise any subscription rights. You cannot give or sell your subscription rights to anybody else; only you can exercise them.
What is the Basic Subscription Privilege? |
The basic subscription privilege of each subscription right entitles you to purchase one share of our common stock at a subscription price of $0.32.
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What is the Over-Subscription Privilege? |
We do not expect that all of our stockholders will exercise all of their basic subscription rights. By extending over-subscription privileges to our stockholders, we are providing stockholders that exercise all of their basic subscription privileges with the opportunity to purchase those shares that are not purchased by other stockholders through the exercise of their basic subscription privileges. The over-subscription privilege entitles you, if you fully exercise your basic subscription privilege, to subscribe for additional shares of common stock not acquired by other holders of rights at the same subscription price of $0.32 per share.
What are the Limitations on the Over-Subscription Privilege? |
We will issue a maximum 22,238,463 shares of common stock in this rights offering. The number of shares available for over-subscription privileges will be 22,238,463 minus the number of shares purchased upon exercise of all basic subscription privileges. If sufficient shares are available, we will seek to honor the over-subscription requests in full. If over-subscription requests exceed the number of shares available, we will allocate the available shares among stockholders that over-subscribed in proportion to the number of shares purchased by those over-subscribing stockholders through the basic subscription privilege. However, if your pro rata allocation exceeds the number of shares you requested, you will receive only the number of shares that you requested, and the remaining shares from your pro rata allocation will be divided among other stockholders exercising their over-subscription privileges that have subscribed for additional shares in proportion to the number of shares purchased by other over-subscribing stockholders through the basic subscription privilege. See “The Rights Offering — Over-Subscription Privilege” for a more detailed explanation of how we will allocate over-subscribed shares. In certain circumstances, however, in order to comply with applicable state securities laws, we may not be able to honor all over-subscription privileges, even if we have shares available.
What if Stockholders do not Exercise Their Subscription Rights in Full? |
Any shares that are not subscribed for in the rights offering may be offered to potential new investors at the same price per share offered in the rights offering, immediately following the expiration of the rights offering. The offering to potential new investors will not be an underwritten offering. Our officers and directors will conduct the offering to potential new investors on our behalf. We reserve the right, in our sole discretion, not to proceed with the offering or sale of shares to the new investors. Before we offer shares of common stock to other potential new investors, we will consider the level of stockholder participation in the rights offering and the amount of net proceeds received from existing stockholders who exercise their subscription rights. In addition, any decision by us to offer shares to potential new investors will be based on our assessment of our capital structure, liquidity, the subscription price of common stock compared with our assessment of the underlying value of our company, and other factors.
Why are We Engaging in a Rights Offering? |
On December 24, 2002, Addison Fischer, Chairman of our Board of Directors, and Phoenix House Investments, LP, an entity controlled by Mr. Fischer, purchased from us an aggregate of 2,552,364.8 shares of our Series A Redeemable Convertible Preferred Stock for gross proceeds of approximately $2.5 million. Each share of Series A Preferred is convertible into shares of common stock at an initial conversion price of $0.32 per share of common stock such that each share of Series A Preferred is initially convertible into 3.125 shares of common stock. We are offering the subscription rights to our current stockholders to permit them to invest in shares of our common stock at the same $0.32 per share price as afforded to Mr. Fischer and Phoenix House.
If we receive proceeds in this rights offering, we intend to use these funds for general working capital purposes and to improve our liquidity. Our Board of Directors has chosen to give you the opportunity to buy more shares and provide us with additional capital. We cannot assure you that we will not need to seek additional financing in the future.
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How Many Shares May I Purchase? |
You will receive 1.25 subscription rights for each share of common stock that you owned on , 2003. Your subscription rights will be aggregated for all of the shares that you owned on that date and then rounded down to the nearest whole number, so that you will not receive any fractional rights. Each subscription right entitles you to purchase one share of common stock for $0.32. The subscription price may be paid in cash or by delivery of shares of Series A Preferred held, which will be valued at $1.00 per share. If you exercise all of the subscription rights that you receive, you may have the opportunity to purchase additional shares of common stock. On the attached subscription certificate, you may request to purchase as many additional shares as you wish for $0.32 per share. We may honor all of the over-subscription requests, but if not, you may not be able to purchase as many shares as you requested on your subscription certificate. Subject to state securities laws and regulations, we have the discretion to issue fewer than the total number of shares that may be available for over-subscription requests in order to comply with state securities laws.
How Did We Arrive at the Offering Price Per Share? |
The offering price per share in this rights offering is equal to the conversion price per share of the Series A Preferred offered and sold in the private placement to Mr. Fischer and Phoenix House during December 2002. A special committee of our Board of Directors, consisting of three independent directors, considered several factors in determining the price at which a share of Series A Preferred may be converted into shares of common stock. These factors included the historic and then current market price of the common stock, our business prospects, our recent and anticipated operating results, general conditions in the securities markets, our need for capital, alternatives available to us for raising capital, the amount of proceeds desired, the pricing of similar transactions, the liquidity of our common stock, the level of risk to our investors, and the need to offer shares at a price that would be attractive to the investors in the private placement relative to the then-current trading price of our common stock. At that time, the special committee obtained an opinion of FTN Financial Securities Corp relating to the fairness, from a financial point of view, of the sale of Series A Preferred. See “The Rights Offering.”
How Do I Exercise My Subscription Rights? |
You must properly complete the attached subscription certificate and deliver it to the Subscription Agent before 5 p.m., Eastern Standard Time, on , 2003. The address for the Subscription Agent is on page . Your subscription certificate must be accompanied by proper payment for each share that you wish to purchase.
How Long Will the Rights Offering Last? |
You will be able to exercise your subscription rights only during a limited period.If you do not exercise your subscription rights before 5 p.m., Eastern Standard Time, on , 2003, your subscription rights will expire.We may, in our discretion, extend the rights offering for up to 60 days. In addition, if the commencement of the rights offering is delayed, the expiration date will similarly be extended.
After I Exercise My Subscription Rights, Can I Change My Mind? |
No. Once you send in your subscription certificate and payment, you cannot revoke the exercise of your subscription rights, even if you later learn information about us that you consider to be unfavorable. You should not exercise your subscription rights unless you are certain that you wish to purchase additional shares of our common stock at a price of $0.32 per share.
Is Exercising My Subscription Rights Risky? |
The exercise of your subscription rights involves certain risks. Exercising your subscription rights means buying additional shares of our common stock, and you should carefully consider this investment as you would view other equity investments. Among other things, you should carefully consider the risks described under the heading “Risk Factors.”
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What Happens If I Choose Not to Exercise My Subscription Rights? |
You will retain your current number of shares of common stock in our company even if you do not exercise your subscription rights. However, if other stockholders exercise their subscription rights and you do not exercise your basic subscription privilege in full, your percentage ownership interest in our company will diminish, and your relative voting rights and economic interests will be diluted.
What Happens To Shares That Are Not Subscribed For in the Rights Offering?
Any shares that are not subscribed for in the rights offering may be offered to certain potential investors who are not currently stockholders, at the same price per share offered in the rights offering, immediately following the expiration of the rights offering. The offering to those potential new investors will not be an underwritten offering, but will be offered by us. We reserve the right, in our sole discretion, to accept or reject subscriptions from potential new investors or not to proceed with the offering or sale of shares to potential new investors.
Can I Sell or Give Away My Subscription Rights?
No.
Must I Exercise Any Subscription Rights?
No.
What Are the Federal Income Tax Consequences of Exercising My Subscription Rights?
The receipt and exercise of subscription rights will be nontaxable for U.S. federal income tax purposes to stockholders who hold their subscription rights and our common stock as capital assets. See “Material United States Federal Income Tax Considerations.” You should seek specific tax advice from your personal tax advisor.
When Will I Receive My New Shares?
If you purchase shares of common stock through this rights offering, you will receive certificates representing those shares as soon as practicable after , 2003. Subject to state securities laws and regulations, we have the discretion to delay allocation and distribution of any shares you may elect to purchase by exercise of your basic or over-subscription privilege in order to comply with state securities laws.
Can We Cancel the Rights Offering?
Yes. Our Board of Directors may cancel the rights offering at any time on or before , 2003, for any reason. If we cancel this rights offering, we will promptly refund any money that we received from stockholders, or return any shares of Series A Preferred tendered by stockholders, without interest.
How Much Money Will SmartDisk Corporation Receive From the Rights Offering?
There is no minimum number of rights that must be exercised in this rights offering, and all net proceeds will be made immediately available to us for the purposes set forth in this prospectus. We cannot assure you that any shares of common stock will be sold in this offering. Our gross proceeds from the rights offering will depend on the number of shares that are purchased and will first be used to cover the costs of the offering. We will not receive additional capital in the event that Mr. Fischer or Phoenix House exercise their subscription rights through the tender of shares of Series A Preferred held by them. Mr. Fischer and Phoenix House have the ability to purchase 7,976,140 shares of common stock in this rights offering through the tender of shares of Series A Preferred, or they may purchase additional shares of common stock for cash and retain the shares of Series A Preferred. Alternatively, if certain conditions occur, Mr. Fischer and Phoenix House will have the ability to convert their shares of Series A Preferred into 7,976,140 shares of common stock. Because the sale
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If we sell all 22,238,463 shares that may be purchased upon exercise of the rights or other sales of unsubscribed shares offered by this prospectus, assuming that Mr. Fischer and Phoenix House exercise their basic subscription rights by tendering shares of Series A Preferred, then we will receive gross proceeds of approximately $4.6 million, before deducting expenses payable by us. We estimate that those expenses will be approximately $350,000.
How Will We Use any Proceeds Received From the Rights Offering?
If we receive any proceeds from this rights offering, we will use the proceeds for general working capital purposes and to improve our liquidity.
How Many Shares Will Be Outstanding After the Rights Offering?
There were 17,790,770 shares of common stock outstanding as of , 2003. The number of shares of common stock that will be outstanding after this rights offering will depend on the number of shares that are purchased. If we sell all of the shares offered by this prospectus, then we will issue 22,238,463 new shares of common stock during this rights offering. In that case, we will have 40,029,233 shares of common stock outstanding after this rights offering.
What If I Have More Questions?
If you have more questions about this rights offering, please contact Crystal Revak, our Director, Corporate Communications, at (239) 436-2500 or by e-mail at crystal.revak@smartdisk.com.
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Summary Consolidated Financial Data
The following summary financial data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and notes thereto, and other financial information included elsewhere in this prospectus. Our consolidated statements of operations data set forth below for the years ended December 31, 1999, 2000, and 2001 and the consolidated balance sheet data as of December 31, 2000 and 2001 have been derived from our audited consolidated financial statements which are included elsewhere in this prospectus. The consolidated statement of operations data set forth below for the years ended December 31, 1997 and 1998 and the consolidated balance sheet data as of December 31, 1997, 1998, and 1999 have been derived from our audited consolidated financial statements which are not included in this prospectus. The balance sheet data and the statement of operations data as of and for the nine months ended September 30, 2001 and 2002 have been derived from our unaudited financial statements, included elsewhere in this prospectus, which we believe have been prepared on the same basis as the audited financial statements and include all adjustments, consisting of normal recurring adjustments, which we consider necessary for a fair presentation of the selected financial data shown.
Nine Months Ended | |||||||||||||||||||||||||||||
Year Ended December 31, | September 30, | ||||||||||||||||||||||||||||
1997 | 1998 | 1999 | 2000 | 2001 | 2001 | 2002 | |||||||||||||||||||||||
(In thousands, except per share amounts) | |||||||||||||||||||||||||||||
Income Statement Data: | |||||||||||||||||||||||||||||
Revenues | $ | 893 | $ | 15,323 | $ | 40,319 | $ | 96,722 | $ | 70,161 | $ | 55,260 | $ | 31,065 | |||||||||||||||
Cost of revenues | 301 | 12,600 | 24,820 | 74,039 | 53,719 | 41,695 | 29,039 | ||||||||||||||||||||||
Gross profit (loss) | 592 | 2,723 | 15,499 | 22,683 | 16,442 | 13,565 | 2,026 | ||||||||||||||||||||||
Operating profit (loss)(1) | (4,016 | ) | (5,581 | ) | 1,763 | (30,044 | ) | (82,590 | ) | (74,759 | ) | (16,291 | ) | ||||||||||||||||
Net income (loss) | (3,964 | ) | (5,503 | ) | 958 | (24,238 | ) | (74,604 | ) | (67,828 | ) | (15,744 | ) | ||||||||||||||||
Earnings (loss) per share — basic(2) | (0.51 | ) | (0.68 | ) | 0.09 | (1.44 | ) | (4.25 | ) | (3.88 | ) | (0.89 | ) | ||||||||||||||||
Earnings (loss) per share — diluted(2) | (0.51 | ) | (0.68 | ) | 0.07 | (1.44 | ) | (4.25 | ) | (3.88 | ) | (0.89 | ) | ||||||||||||||||
Balance Sheet Data (at end of period): | |||||||||||||||||||||||||||||
Total assets | 1,607 | 11,136 | 63,444 | 126,309 | 36,078 | 47,799 | 18,914 | ||||||||||||||||||||||
Long-term debt | 645 | 648 | — | — | — | — | — | ||||||||||||||||||||||
Redeemable common stock | — | 9,992 | — | — | — | — | — | ||||||||||||||||||||||
Stockholders’ equity (deficit) | (4,626 | ) | (6,336 | ) | 49,787 | 100,315 | 25,114 | 32,594 | 9,995 |
(1) | Loss in 2000, 2001, and nine months ended September 30, 2002 reflects approximately $24.7 million, $25.9 million, and $3.2 million, respectively, in amortization of goodwill and other acquisition related intangible assets recorded in connection with the VST and Impleo acquisitions. In addition, loss in 2001 and nine months ended September 30, 2002 reflects approximately $43.8 million and $2.7 million, respectively, of impairment charges to reduce the carrying value of goodwill and other acquisition related intangible assets recorded in connection with the VST and Impleo acquisitions. |
(2) | Shares used in computing earnings (loss) per share reflect the retroactive adjustment of outstanding shares related to the mergers of SmartDiskette Limited and SmartDisk Security Corporation into SmartDisk, as well as the one for four reverse stock split completed in August 1999. |
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RISK FACTORS
You should carefully consider the following factors and other information in this prospectus before deciding to purchase shares of our common stock in the rights offering.
We may need additional financing to continue to carry on our existing operations beyond December 31, 2003, and such additional financing may not be available.
We have minimal financial resources and cash flow from operating activities historically has been insufficient to meet our operating needs and other payment obligations. Our cash and cash equivalents have decreased over each of the last several quarters. As of December 31, 2001, we had cash and cash equivalents of $14.5 million, and as of September 30, 2002, we had cash and cash equivalents of $2.862 million. As part of our efforts to improve our liquidity and financial condition, during December 2002, we completed a private placement to Addison Fischer, the Chairman of our Board of Directors, and Phoenix House Investments, LP, an entity controlled by Mr. Fischer, who purchased from us an aggregate of 2,552,364.8 shares of our Series A Redeemable Convertible Preferred Stock for gross proceeds of approximately $2.5 million.
After giving effect to this investment and the implementation of our restructuring plan discussed elsewhere in this prospectus, and based on our current forecasted operations, we believe that our cash and cash equivalents and working capital will be sufficient to meet our operating requirements through December 31, 2003. However, we may be required to reduce our operations or to obtain additional financing if our forecast proves inaccurate for any reason, including the following:
• | our revenue fails to meet our forecast and continues to decline; | |
• | our gross profit fails to meet our forecast and continues to erode; | |
• | our operating expenses exceed our forecast; | |
• | cash is required to collateralize letters of credit for issue to vendors or to prepay vendors for the supply of products or services; | |
• | cash flow from accounts receivable is reduced further or interrupted by slow collections or product returns; | |
• | procurement of inventory exceeds market demand; | |
• | purchase orders issued for the procurement of inventory in excess of market demand cannot be cancelled with the consequent negative impact on cash; | |
• | vendors unilaterally change the payment terms under which they will supply product or services to us; or | |
• | unanticipated events adversely effect our operations or cash flows. | |
In addition, our continued viability beyond December 31, 2003 will depend upon our ability to generate cash from operations or to obtain additional working capital. Such additional capital, if required, may not be available to us or may be available on terms that may be unacceptable to us. These liquidity problems, among others, raise substantial doubt about whether we can continue as a going concern.
As of September 30, 2002, we had cash-collateralized commercial and standby letters of credit of $2.107 million which were issued to certain of our vendors. Although we did not have any outstanding commercial letters of credit at December 31, 2002, we cannot assure you that additional standby or commercial letters of credit will not be required by our vendors and that, if so required, the cash will be available to fund the collateral.
In addition to the proceeds from this rights offering, we will likely need additional sources of financing in order to carry on our operations as presently conducted, which considers the implementation of our restructuring plan discussed elsewhere in this prospectus. Any financing may include bank borrowings or public or private offerings of equity or debt securities. We cannot assure you that such additional sources of
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• | maintain, develop or enhance our product offerings; | |
• | take advantage of future opportunities; | |
• | respond to competitive pressures; or | |
• | continue operations. | |
The proceeds from this rights offering may be insufficient to improve our liquidity.
We may not generate from this rights offering sufficient net proceeds to improve our liquidity. Because the net proceeds received in this offering depends upon the participation of the current stockholders and our decision of whether to offer shares of common stock to possible new investors, we cannot assure you that the net proceeds received, if any, will be sufficient to improve our liquidity. In addition, we will not receive additional capital in the event that Mr. Fischer or Phoenix House exercise their subscription rights through the tender of shares of Series A Preferred held by them. Mr. Fischer and Phoenix House have the ability to purchase 7,976,140 shares of common stock in this rights offering through the tender of shares of Series A Preferred. Alternatively, if certain conditions occur, shares of Series A Preferred held by Mr. Fischer and Phoenix House will convert into 7,976,140 shares of common stock.
Additional funds raised through the issuance of equity securities may have negative effects on our stockholders.
Additional funds raised through the issuance of equity securities or securities convertible into our common stock may have the following negative effects on the then current common stockholders:
• | dilution in percentage of ownership in our company; and | |
• | the rights, preferences or privileges of the new security holders may be senior to those of the common stockholders. | |
If our securities are removed from NASDAQ listing, you may have more difficulty purchasing and selling our common stock.
Our securities are currently listed and traded on the NASDAQ SmallCap Market. To maintain our listing, we must meet NASDAQ’s continued listing standards, including minimum stockholders’ equity, number of stockholders and bid price. Prior to December 2002, our common stock was listed and traded on the NASDAQ National Market. During June and July 2002, we received notice from NASDAQ that we were not in compliance with NASDAQ’s continued listing standards regarding minimum $1.00 bid price and minimum $5.0 million market value of publicly held shares. On September 27, 2002, NASDAQ notified us that because we had not regained compliance with those listing standards, our common stock would be delisted from the NASDAQ National Market at the opening of business on October 7, 2002. On October 3, 2002, we appealed the delisting and requested an oral hearing before a NASDAQ Qualifications Panel to consider our continued listing. The hearing was held on October 31, 2002, at which the NASDAQ Staff recommended that our common stock be transferred to the NASDAQ SmallCap Market. As of December 4, 2002, NASDAQ transferred our listing to the NASDAQ SmallCap Market. On January 3, 2003, NASDAQ notified us that it had extended to us an additional 180-day grace period, through July 7, 2003, to evidence compliance with the $1.00 bid price requirement. If we fail to meet the minimum bid price requirement of the NASDAQ SmallCap Market by that time, our common stock may be delisted from the NASDAQ SmallCap Market. There can be no assurance that we will comply with the continued listing standards in the future. If
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As a result of our operating losses, decrease of available cash and cash equivalents, and other factors, our auditors have raised substantial doubt about our ability to continue as a going concern.
We have incurred net losses on a quarterly basis since the first quarter of 2000. We had cash and cash equivalents of approximately $14.517 million and $2.862 million as of December 31, 2001 and September 30, 2002, respectively. We have minimal financial resources, and our cash flow from operating activities continues to be insufficient to meet our operating needs and other payment obligations. After giving effect to the proceeds received from the private placement during December 2002 and the implementation of our restructuring plan, and based on our current forecasted operations, we believe that our cash and cash equivalents and working capital will be sufficient to meet our operating requirements through December 31, 2003. See “Risk Factors — We may need additional financing to continue to carry on our existing operations beyond December 31, 2003, and such additional financing may not be available.” As a result of these liquidity problems, among others, our auditors have raised substantial doubt about our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments related to the recoverability of recorded asset amounts that might be necessary as a result of this uncertainty. As a result of receiving this opinion from our independent public accountants, we may experience possible adverse effects from our customers, on our creditworthiness, or on investor confidence, any of which may have a material adverse effect on our business and the trading price of our common stock. Our ability to continue as a going concern depends upon the success of our restructuring and cost containment measures as well as our ability to improve our liquidity, whether through cash generated by operations or through the issuance of debt or equity securities, such as the sale of securities in this rights offering.
During the nine months ended September 30, 2002, approximately 21% of our revenue was derived from the sale of our FlashPath products, and we expect sales from these products to decline in the future.
To date, a substantial portion of our revenue has been derived from the sale of only a few major products. While our long-term strategy is to derive revenue from multiple products, we anticipate that the sale of our FlashPath products will continue to represent a substantial portion of our net revenue through 2002. During the nine months ended September 30, 2002, we derived approximately 21% of our product revenue from the sale of FlashPath products. Sales of these products have been declining for the past four consecutive quarters, which is seriously harming our business. As a result of decreased sales, we announced our decision to discontinue the sale of FlashPath products to OEM partners during the three-month period ended September 30, 2002. We expect the decline in sales of FlashPath products to continue as customers move towards devices with higher transfer speeds, resulting in lower revenue from digital connectivity products in 2002 than in 2001.
Reduced consumer demand for our FlashPath products and our decision to discontinue sales of FlashPath products to our OEM partners will have a significant impact on our business.
Our current FlashPath products and other flash media readers are designed to provide connectivity between personal computers and digital appliances that use flash memory cards. Our current dependence on sales of FlashPath exposes us to a substantial risk of loss in the event that the flash memory market does not continue or if a competing technology replaces flash memory cards. If a competing memory storage device replaces or takes significant market share from the flash memory cards, which our digital connectivity products support, we will not be able to sell our products in quantities sufficient to grow or maintain our current business.
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We do not have adequate financial resources to invest in new products and introduce them in a timely manner.
We operate in an industry that is subject to evolving industry standards, rapid technological changes, rapid changes in consumer demands and the rapid introduction of new, higher performance products that shorten product life cycles. To be competitive in this demanding market, we must both continue to refine current products so that they remain competitive, and continually design, develop and introduce, in a timely manner, new products that meet the performance and price demands of OEMs and consumers. To date, we have not developed new products to reduce our dependence on FlashPath or USB- and FireWire-based personal storage products. Product development is inherently risky because it is difficult to foresee developments in technology, coordinate our technical personnel and strategic relationships, and identify and eliminate design flaws. These development activities require the investment of substantial resources before revenue is derived from product sales. We do not have adequate financial resources to maintain the necessary development activities and we do not expect to have adequate financial resources in the foreseeable future. The failure to release commercially successful new products adversely affects our financial condition, provides competitors a first-to-market opportunity and allows competitors to achieve greater market share. Further, we are not able to recoup research and development expenditures when new products are not widely commercially accepted. If we are unable to develop new products, then we must acquire new products or product technologies. Because of our weak financial position and limited liquidity we do not expect to be able to acquire new products in the foreseeable future.
A reduction in the use of the 3.5-inch floppy disk drive by consumers and manufacturers is contributing to the decrease in sales of our FlashPath products.
Our current FlashPath products only work in conjunction with the standard 3.5-inch floppy disk drive. While the 3.5-inch floppy disk drive is found today in most personal computers, a number of newer personal computer models do not have this device and new industry standards may emerge that render the 3.5-inch floppy disk drive obsolete. In the future, we will have to rely on our other products and develop or acquire new products that use a different interface between personal computers and digital appliances.
Since our FlashPath products work only in conjunction with the 3.5-inch floppy disk drive, advances in flash memory cards make these products less competitive because of the increased time needed to transfer data using the 3.5-inch floppy disk drive.
Consumer acceptance of our FlashPath products depends upon their ability to transfer quickly information from flash memory cards to personal computers. However, the time needed to transfer information using a 3.5-inch disk drive increases as more data is transferred. As more memory is condensed onto flash memory cards, the time necessary to transfer all of the data from a single card increases. As technological advances make it possible and feasible to produce higher density cards, FlashPath is constrained by the inherent limitations of the 3.5-inch disk drive. Consequently, FlashPath is becoming less attractive to consumers, thus contributing to the decline in our sales.
Our sales of digital connectivity products may also be harmed if a single standard for flash memory cards emerges.
We believe that demand for our flash memory connectivity products is also driven, to a large extent, by the absence of a single standard for flash memory cards. There are currently five major flash memory cards, none of which has emerged as the industry standard. Should one of these cards or a new technology emerge as an industry standard, flash memory card readers could be built into personal computers, eliminating the need for our current flash memory connectivity products.
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We may not be able to sell sufficient quantities of our personal storage products to sustain our future growth if PC manufacturers do not adopt IEEE 1394 as a high-speed peripheral interface or if a competing CPU interface displaces or prevents the widespread adoption of IEEE 1394.
A substantial portion of our business depends on the adoption of Institute of Electrical and Electronics Engineering, or IEEE, 1394 technology by personal computer manufacturers. IEEE 1394 is a high-speed computer interface that is replacing Small Computer System Interface, or SCSI, and parallel interfaces. If these manufacturers do not include an IEEE 1394 interface on their personal computers or notebook computers, then we may not be able to sell sufficient quantities of our FireWire personal storage products to support our future growth. FireWire is Apple’s trade name for IEEE 1394. For example, a competing high-speed interface, such as Universal Serial Bus, or USB, 2.0, could emerge as an industry standard, thus limiting the demand for our FireWire technology and related personal storage products.
We may not be able to sell sufficient quantities of our personal storage products to support our business if suppliers of our drives develop native FireWire-based personal storage products that do not require our FireWire conversion technology.
We embed conversion ASICs and integrated software drivers in the hard disk drives we obtain from our suppliers, which enables our FireWire-based personal storage products to be used with FireWire-equipped computers. We license this technology and the firmware from Texas Instruments and other integrated circuit suppliers. If our suppliers of drives were to develop a native FireWire solution that does not require the conversion ASICs and drivers embedded in our products, then we may not be able to sell sufficient quantities of our FireWire personal storage products to support our business.
We may not be able to develop or maintain the strategic relationships necessary to provide us with the insight we need to develop commercially viable products.
We may not be able to produce commercially viable products if we are unable to anticipate market trends and the price, performance and functionality requirements of flash memory card, personal computer and digital appliance manufacturers. We must continue to collaborate closely with our customers, our OEM manufacturers and our other contract manufacturers to ensure that critical development projects proceed in a coordinated manner. This collaboration is also important because our ability to anticipate trends and plan our product development activities depends to a significant degree upon our continued access to information derived from these strategic relationships. We currently rely on strategic relationships with personal computer manufacturers, such as Apple, and consumer product OEMs, such as Olympus. If we cannot maintain our relationships, we may not be able to continue to develop products that are compatible with their personal computers and digital appliances. If any of our current relationships deteriorates or is terminated, or if we are unable to enter into future alliances that provide us with comparable insight into market trends, we will be hindered in our ability to produce commercially viable products.
We also maintain relationships with foreign entities. There are inherent difficulties in developing and maintaining relationships with foreign entities. Language and cultural differences often impair relationships, and geographical distance, at times, is also an impediment. If any of our current relationships is impaired, or if we are unable to develop additional strategic relationships in the future, our product development costs would significantly increase and our business would be materially and adversely affected.
We may not be able to sustain our relationship with Apple Computer, which would greatly hinder our ability to timely develop products that are compatible with Macintosh operating systems.
Historically, Apple has provided us, as an Apple developer, access to selected product road maps, which has allowed us to develop and engineer timely many of our current products, including our most popular storage products. As a result of this collaborative relationship, we have received approximately 10% of our revenue during fiscal year 2000, approximately 22% of our revenue during fiscal year 2001, and approximately 15% or our revenue during the nine months ended September 30, 2002 from direct sales to Apple users. Moreover, we anticipate that a significant portion of our product revenue will continue to be derived from sales
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A decline in the demand for Apple products would further reduce the market for many of our products.
Our growth depends to a large extent on both our strategic relationship with Apple and demand for Apple products. This dependence is due primarily to the fact that, to date, Apple has been the principal personal computer manufacturer using the FireWire interface technology on which many of our products are based. If a decline in the demand for Apple products occurs or if Apple suffers a material change in its business, the market for many of our products would be negatively impacted.
We may fail to adequately protect our intellectual property and, therefore, lose our competitive advantage.
Our proprietary technology with respect to 3.5-inch floppy disk drive interfaces and USB and FireWire source codes is critical to our future growth. We rely in part on patent, trade secret, trademark and copyright law to protect our intellectual property. However, the patents issued to us may not be adequate to protect our proprietary rights, to deter misappropriation or to prevent an unauthorized third party from copying our technology, designing around the patents we own or otherwise obtaining and using our products, designs or other information. In addition, we may not receive trademark protection for our “SmartDisk” name. We have filed for trademark registration of the name “SmartDisk,” but this has not yet been granted. We are aware of a trademark application for the name “SmartDisk” that was filed by another company. Our application could be denied and we could be prohibited from using the “SmartDisk” name. In that event, we would be required to incur substantial costs to establish new name recognition.
We also claim copyright protection for some proprietary software and documentation. We attempt to protect our trade secrets and other proprietary information through agreements with our customers, employees and consultants, and through other security measures. However, despite our efforts to protect our intellectual property, unauthorized parties may attempt to copy aspects of our products or obtain and use information and software that we regard as proprietary. Those parties may have substantially greater financial resources than we have, and we may not have the resources available to challenge their use of our proprietary technology. If we fail to adequately protect our intellectual property, it will be easier for our competitors to sell competing products.
We may face competition from Intel if it decides to utilize its competing patent.
Intel Corporation was issued a patent in 1997 disclosing and claiming technology substantially similar to that disclosed in one of our key patents. The Intel patent was filed four years after our effective filing date, and we do not believe that the Intel patent can be validly applied to any of the technology disclosed in our patent. However, given the substantial resources available to Intel, our financial condition could suffer if we engage in a dispute with Intel. Our business could also be harmed if Intel’s patent is determined to be valid and Intel or any licensee of Intel decides to sue our customers or develop and commercialize products based on its patent.
Infringement claims by third parties could result in costly litigation and otherwise adversely impact our business.
From time to time we may receive communications from third parties asserting that our products infringe, or may infringe, the proprietary rights of these third parties. These claims of infringement may result in protracted and costly litigation that could require us to pay substantial damages or have sales of our products stopped by an injunction. Infringement claims could also cause product shipment delays, require us to redesign our products or require us to enter into royalty or licensing agreements, any of which could harm
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Our operating results have fluctuated significantly and may fluctuate significantly in the future, which could lead to decreases in our stock price.
Our operating results have fluctuated significantly in the past and we expect that they will continue to fluctuate in the future. If our future operating results materially fluctuate or are below the expectations of stock market analysts or investors, our stock price would likely decline. Future fluctuations may result from a variety of factors, including the following:
• | The timing and amount of orders we receive from our customers, which may be tied to seasonal demand for the consumer products manufactured and sold by OEMs; | |
• | Cancellations or delays of customer product orders, or the loss of a significant customer; | |
• | Reductions in consumer demand for our customers’ products in general, such as Apple products, or for our products in particular, such as FlashPath; | |
• | The timing and amount of research and development expenditures; | |
• | The availability of manufacturing capacity necessary to make our products; | |
• | General business conditions in our markets in the United States, Japan and Europe, as well as general economic and political conditions; | |
• | Any new product introductions, or delays in product introductions, by us or by our competitors; | |
• | Increased costs charged by our suppliers or changes in the delivery or products to us; | |
• | Increased competition or reductions in the average selling prices that we are able to charge; | |
• | Fluctuations in the value of foreign currencies, particularly the Japanese yen and British Pound, against the U.S. dollar; and | |
• | Changes in our product mix as well as possible seasonal demand for our products. |
As a result of these and other factors, we believe that period-to-period comparisons of our historical results of operations are not a good predictor of our future performance.
The stock market has experienced significant price and volume fluctuations that have particularly affected the market prices of the stocks of technology companies. Recently, the market price of our common stock, like that of many technology companies, has experienced significant fluctuations. For instance, from October 6, 1999, the date of our IPO, to January 29, 2003, the reported last sale price for our common stock
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The market price of our common stock also has been and is likely to continue to be significantly affected by expectations of analysts and investors. Reports and statements of analysts do not necessarily reflect our views. The fact that we have in the past met or exceeded analyst or investor expectations does not necessarily mean that we will do so in the future.
We have indemnification obligations related to our intellectual property, which may require us to pay damages.
Our arrangements with Fuji Photo USA, Iomega, SanDisk, Sony, Toshiba and others require us to indemnify them for any damages they may suffer if a third party claims that we are violating their intellectual property rights. While, to date, we have not received indemnification claims, there may be future claims. For example, Fuji Photo USA has been named as a co-defendant in the above referenced complaint initiated in California. We have agreed to indemnify Fuji Photo USA with respect to expenses or damages incurred by Fuji Photo USA in connection with this matter. Any indemnification claim may require us to pay substantial damages, which could negatively impact our financial condition.
Any settlement or claim awarded against us as a result of the securities class action suit filed against us could negatively affect our operating results and financial condition.
On July 26, 2001, a securities class action suit was filed against us, several of our executive officers and directors, including Addison M. Fischer, Michael S. Battaglia and Michael R. Mattingly, and the following underwriters of our initial public offering: FleetBoston Robertson Stephens, Inc. (formerly BancBoston Robertson Stephens, Inc.), Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. The suit was filed in the United States District Court for the Southern District of New York on behalf of all persons who acquired our common stock between October 6, 1999 and December 6, 2000. The complaint charges defendants with violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, for issuing a registration statement and prospectus that contained material misrepresentations and/or omissions. The complaint alleges that the prospectus was false and misleading because it failed to disclose (i) the agreements between FleetBoston Robertson Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain investors to provide them with significant amounts of restricted shares of our common stock in the IPO in exchange for excessive and undisclosed commissions; and (ii) the agreements between FleetBoston Robertson Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain customers under which the underwriters would allocate shares of our common stock in the IPO to those customers in exchange for the customers’ agreement to purchase shares of our common stock in the after-market at pre-determined prices. The complaint seeks an undisclosed amount of damages, as well as attorney fees. We consider this claim, as it relates to us, to be wholly without merit and we will vigorously defend against such claim. Any settlement or claim awarded against us as a result of the securities class action suit filed against us could negatively affect our operating results and financial condition.
During 2001, three additional class action suits were filed against one of the underwriters in our initial public offering, FleetBoston Robertson Stephens, Inc. The suits were also filed in the United States District Court for the Southern District of New York on behalf of all persons who acquired our common stock between October 6, 1999 and December 6, 2000. These complaints make similar allegations that the registration statement and prospectus violate section 10(b) of the Exchange Act and Rule 10b-5 as a result of the undisclosed agreements between FleetBoston Robertson Stephens and certain inventors and customers. The complaints seek an undisclosed amount of damages, as well as attorney fees. These cases have been consolidated and we, together with all or substantially all of the underwriters, issuers and individual defendants in these consolidated class actions, have moved to dismiss all of the consolidated amended complaints, including those directed against us, as legally insufficient. All discovery in these consolidated actions has been stayed pending determination of the motions to dismiss. Pursuant to the terms of a tolling agreement, the action has been dismissed without prejudice against each of the individual defendants named in the suit. We
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We may have particular difficulty protecting our intellectual property rights overseas.
The laws of some foreign countries do not protect proprietary rights to as great an extent as do the laws of the United States, and many U.S. companies have encountered substantial infringement problems in some foreign countries. Because many of our products are sold and a portion of our business is conducted overseas, primarily Japan and Europe, our exposure to intellectual property risks may be higher.
Because most of our sales are to Apple, Ingram Micro, and Sony, the loss of any of these key customers would seriously harm our business.
Our business will be seriously harmed if we lose any of our significant customers, particularly Apple, Ingram Micro or Sony, or suffer a substantial reduction in or cancellation of orders from these customers. Our current distribution strategy results in sales to a limited number of customers, which account for a significant portion of our net revenue. Some of our products are sold as stand-alone products by OEMs and, to a lesser extent, are bundled together and sold with systems manufactured by third party OEMs. During the nine months ended September 30, 2002, Apple accounted for $5.125 million, or approximately 15% of our revenue, Ingram Micro accounted for $5.070 million, or approximately 15% of our revenue, and Sony accounted for $2.849 million, or approximately 9% of our revenue. Our top five customers collectively accounted for approximately 51% of our revenue during the same period. We expect sales of our products to a limited number of customers to account for a significant portion of our net revenue during 2002. As a result of our decision to discontinue sales of our Flash Path products to OEM partners, however, we expect sales to Sony to decrease substantially in the future.
Since we sell our products to a limited number of large customers, any pressure on us from these customers to make price concessions would reduce our future gross margins.
Our reliance on sales to a limited number of large customers may expose us to pressure for price concessions. Because of this reliance and because of our dependence on OEMs and distributors as a significant distribution channel, we expect that they may seek price concessions from us, which would reduce our average selling prices and our gross margins. Since we do not manufacture our own products, we may be unable to reduce our manufacturing costs in response to declining average per unit selling prices.
Our customers could stop purchasing our products at any time because we do not have long-term purchase contracts with them.
No OEM or other customer is contractually obligated to purchase products from us. As a result, our customers are free to cancel their orders or stop ordering our products at any time. In addition, even if we are able to demonstrate that our products are superior, OEMs may still choose not to bundle our products with theirs or market and distribute our products on a stand-alone basis. OEMs may also change their business strategies and manufacturing practices, which could cause them to purchase fewer of our products, find other sources for products we currently manufacture, or manufacture these products internally.
Our ability to sell our products will be limited if the OEMs’ products do not achieve market acceptance or if the OEMs do not adequately promote our products.
We depend upon our OEM customers to market certain of our products. Failure of the OEMs’ products to achieve market acceptance, the failure of the OEMs to bundle our products with theirs, or any other event causing a decline in our sales to the OEMs could seriously harm our business. Even if consumers buy OEMs’ products, their ultimate decision to buy our products depends on OEM packaging, distribution and sales efforts, which may not be sufficient to maintain or increase sales of our products. If we cannot achieve or
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A new or competing data transfer solution that achieves significant market share or receives significant support from manufacturers would jeopardize our business.
Our products currently compete with a number of cable and non-cable interfaces between personal computers and digital appliances, including ports, PCMCIA slots and infrared interfaces, all of which are PC peripheral interfaces. It is possible that one of these competing data transfer solutions, or another existing or new technology, could achieve a significant market presence or become supported by a number of significant flash memory card, personal storage or digital appliance manufacturers. Regardless of the relative benefits of our products, if a competing product gains significant market share or significant support of flash card manufacturers, this product would likely emerge as the industry standard and thereby achieve a dominant market position that would jeopardize our survival.
We expect to continue outsourcing key operational functions and our ability to do so will be impaired if we are unable to maintain our strategic relationships.
We have formed strategic relationships with a number of significant industry participants, including Apple, Mitsumi, Olympus, Sony, Toshiba, Toyota Tsusho, Yamaichi, and others. We depend upon these corporations to perform key distribution, manufacturing, marketing, and other functions. For example, Mitsumi, Toyota Tsusho, and Yamaichi currently manufacture some of our products, Toshiba, Apple, Olympus and Sony market certain of our products. We expect that these and similar types of relationships will be critical to our business because we intend to continue outsourcing many key operational functions and we do not currently have the resources to perform these functions ourselves.
A portion of our sales and expenses are geographically concentrated in Japan, and, therefore, we could suffer from exchange rate fluctuations and economic and political difficulties.
Approximately 16% and 7% of our revenue for the nine months ended September 30, 2002 was attributable to sales to Japanese and European customers, respectively. We expect sales to Japanese and European customers will continue to account for a portion of our total revenue for the foreseeable future. All of our Japanese sales, as well as the related expenses, are denominated in Japanese yen. Fluctuations in exchange rates between the yen and the U.S. dollar, particularly with respect to Japanese transactions denominated in a currency other than the yen, could adversely impact our financial results. All of our European sales, as well as the related expenses, are denominated in British pounds. Fluctuations in exchange rates between the pound and the U.S. dollar, particularly with respect to European transactions denominated in a currency other than the pound, could adversely impact our financial results. Some transactions and accounts of our Japanese and European subsidiary are U.S. dollar denominated. Since the foreign subsidiaries’ accounting records are kept in local currency, those U.S. dollar denominated transactions are accounted for using the local currency at the time of the transaction. U.S. dollar denominated accounts are remeasured at the end of the accounting period. This remeasurement results in adjustments to income. In addition, the balance sheet accounts of our foreign subsidiaries are translated to the U.S. dollar for financial reporting purposes and resulting adjustments are made to stockholders equity. The value of the Japanese yen and the British pound may deteriorate against the dollar, which would impair the value of stockholders’ investment in us. Fluctuations in the value of the Japanese yen and the British pound against the dollar have occurred in the nine months ended September 30, 2002. These fluctuations resulted in a foreign currency translation adjustment to increase stockholders’ equity by approximately $0.583 million as of September 30, 2002, which is included in accumulated and other comprehensive income (loss) and shown in the equity section of our balance sheet. Further, we do not currently hedge against foreign currency exposure. In the future, we could be required to denominate our product sales in other currencies, which would make the management of currency fluctuations more difficult and expose us to greater currency risks.
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We depend on a limited number of contract and offshore manufacturers, and it may be difficult to find replacement manufacturers if our existing relationships are impaired.
We contract with offshore manufacturers to produce some of our products and our dependence on a limited number of contract manufacturers exposes us to a variety of risks, including shortages of manufacturing capacity, reduced control over delivery schedules, quality assurance, production yield and costs. For example, Mitsumi and Yamaichi are the sole manufacturers of our FlashPath products and Jess-Link and Mitsumi are the sole manufacturers of our disk drive products. If Jess-Link, Mitsumi or Yamaichi terminates production, or cannot meet our production requirements, we may have to rely on other contract manufacturing sources or identify and qualify new contract manufacturers. We order products from these manufacturers on a purchase order basis and our arrangements do not provide exclusivity to either party. The lead-time required to qualify a new manufacturer could range from three to six months. Despite efforts to do so, we may not be able to identify or qualify new contract manufacturers in a timely manner and these new manufacturers may not allocate sufficient capacity to us in order to meet our requirements. Any significant delay in our ability to obtain adequate quantities of our products from our current or alternative contract manufacturers would cause our sales to decline.
Our dependence on foreign manufacturing and international sales exposes us to difficulties often not encountered by exclusively domestic companies.
Many of our products are manufactured overseas and a significant portion of our revenue is derived from overseas sales. Approximately 23% of our revenue during the nine months ended September 30, 2002 was derived from customers located outside the United States. Our dependence on foreign manufacturers and international sales poses a number of risks, including, but not limited to:
• | Difficulties in monitoring production; | |
• | Transportation delays and interruptions; | |
• | Unexpected changes in regulatory requirements; | |
• | Currency exchange risks; | |
• | Tariffs and other trade barriers, including import and export restrictions; | |
• | Difficulties in staffing and managing disparate branch operations; | |
• | Political or economic instability; | |
• | Compliance with foreign laws; | |
• | Difficulties in protecting intellectual property rights in foreign countries; | |
• | Exchange controls; and | |
• | Potential adverse tax consequences, including with respect to repatriation of earnings. |
We intend to continue manufacturing our products overseas and we anticipate that international sales will continue to account for a significant portion of our revenue. Therefore, we expect to be subject to the risks outlined above for the foreseeable future.
We have a limited number of suppliers of key components and our ability to produce finished products will be impaired if we are unable to obtain sufficient quantities of some components.
Rohm is our sole provider of application specific integrated circuits, or ASICs, for our FlashPath products. In our FlashPath products, the specific function of these integrated circuits is the conversion of digital and analog data. In addition, Texas Instruments is our primary supplier of ASICs for our FireWire products. Our dependence on a limited number of suppliers and our lack of long-term supply contracts exposes us to several risks, including a potential inability to obtain an adequate supply of components, price increases, late deliveries and poor component quality. Disruption or termination of the supply of components could delay
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Our current and potential competitors have significantly greater resources than we do, and increased competition could harm sales of our products.
Many of our current and potential competitors have significantly greater financial, technical, marketing, purchasing and other resources than we do. As a result, many of our competitors are able to respond more quickly to new or emerging technologies or standards or to changes in customer requirements. Many of our competitors are also able to devote greater resources to the development, promotion and sale of products, and are able to deliver competitive products at a lower end-user price. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our prospective customers. Therefore, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition is likely to result in price reductions, reduced operating margins and loss of market share. Any of these factors could have a material adverse effect on our business and operating results.
Our business may suffer if we are unable to manage our restructuring or growth.
Material restructuring or growth, should it occur, is likely to place a burden on our operating and financial systems as well as our senior management and other personnel. Existing and new members of management may not be able to improve existing systems and controls or implement new systems and controls in response to such restructuring or growth. Management of our operations in diverse locations may also complicate the task of managing this change.
We may not be able to integrate the business of companies we acquire and therefore these acquisitions may not provide additional value to our stockholders.
We continually evaluate potential acquisitions of complementary businesses, products and technologies. We acquired VST in March 2000 and Impleo in April 2000. We may not realize the desired benefits of these transactions or of future transactions and significant underperformance relative to expected results or other factors could materially and adversely affect our financial results. See “Risk Factors — Our acquisitions have resulted in significant impairment charges.” In order to successfully integrate acquired companies we must, among other things:
• | Continue to attract and retain key management and other personnel; | |
• | Integrate the acquired products from both an engineering and sales and marketing prospective; | |
• | Establish a common corporate culture; and | |
• | Integrate geographically distant facilities, systems and employees. |
If our management’s attention to day-to-day operations is diverted to integrating acquired companies or if problems in the integration process arise, our business could be adversely affected and we could be required to use a significant portion of available cash.
If an acquisition is made utilizing our securities, significant dilution to our stockholders and significant acquisition related charges to earnings could occur.
We may incur additional charges in the future resulting from redundancies in product lines, personnel and fixed assets associated with these acquisitions. For instance, on May 31, 2001, we announced our intention to close our Acton, Massachusetts facility and move those operations into our Naples, Florida headquarters. This closing allowed us to centralize our operations and marketing and development efforts, improve operational efficiencies and otherwise increase the effectiveness of our business. In connection with this
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Our acquisitions have resulted in significant impairment charges.
We acquired VST in March 2000 and Impleo in April 2000. We continually evaluate the recoverability of our long-lived assets, such as goodwill and other acquisition related intangible assets. An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important that could trigger an impairment review include significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the overall business, a significant decline in our stock price for a sustained period, the market capitalization relative to net book value and significant negative industry or economic trends that indicate that this trend may continue for an indefinite period of time. If we determine that the carrying value may not be recoverable based upon the existence of one or more of the above indicators of impairment, any impairment measured is based on a projected discounted cash flow method using a discount rate commensurate with the risk inherent in our current business model.
Based on our impairment review performed for the quarter ended September 30, 2001, we recorded a $42.0 million impairment charge to reduce goodwill and other acquisition related intangible assets recorded in connection with our acquisition of VST. In addition, based on impairment reviews performed for the quarters ended December 31, 2001 and March 31, 2002, we recorded impairment charges of $1.8 million and $2.2 million, respectively, to reduce goodwill and other acquisition related intangible assets recorded in connection with our Impleo acquisition.
We could be held liable for product defects, which could require us to pay substantial damages and harm our reputation with our customers.
Complex products such as ours can contain errors, defects and bugs when first introduced or as new versions are released. Delivery of products with production defects or reliability, quality or compatibility problems could hinder market acceptance of our products, which could damage our reputation and harm our ability to attract and retain customers. Errors, defects or bugs could also cause interruption, delays or a cessation of sales to our customers, and could subject us to warranty claims from our customers. We would have to expend significant capital and resources to remedy these problems. Errors, defects or bugs could be discovered in our new products after we begin commercial production of them, despite testing by us and our suppliers and customers. This could result in additional development costs, loss of, or delays in, market acceptance, diversion of technical and other resources from our other development efforts, claims by our customers or others against us or the loss of credibility with our current and prospective customers.
Our executive officers and key personnel are critical to our business, and these officers and personnel may not remain with us in the future.
We depend upon the continuing contributions of our key management, sales and product development personnel. The loss of any of those personnel could seriously harm us. Although some of our officers are subject to employment agreements, we cannot be sure that we will retain their services. In addition, we have not obtained key-person life insurance on any of our executive officers or key employees.
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Risks Related to this Rights Offering
If you do not exercise all of your subscription rights, you may suffer significant dilution of your percentage ownership of our common stock.
This rights offering is designed to allow all current stockholders to purchase additional shares of common stock at a fixed price to be determined before the rights offering begins and in an amount proportional to the stockholders’ existing interests. The purpose of this structure is to enable us to raise capital while allowing current stockholders to maintain their relative proportionate voting and economic interest. To the extent that current stockholders do not exercise their subscription rights and shares are purchased by other stockholders in this rights offering, and to the extent we issue to possible new investors additional shares of common stock in this offering, the proportionate voting interest of the non-exercising stockholders will be reduced significantly, and the percentage of our expanded equity that their original shares represent after exercise of the subscription rights will be disproportionately diluted.
The chairman of our board of directors may have the ability to control our company before and after completion of this rights offering.
On December 24, 2002, Addison Fischer, Chairman of our Board of Directors, and Phoenix House Investments, LP, an entity controlled by Mr. Fischer, purchased from us an aggregate of 2,552,364.8 shares of our Series A Redeemable Convertible Preferred Stock for gross proceeds of approximately $2.5 million. Each share of Series A Preferred is convertible into shares of common stock at an initial conversion price of $0.32 per share of common stock such that each share of Series A Preferred is initially convertible into 3.125 shares of common stock. However, in no event may the aggregate number of shares of common stock issuable upon conversion of all shares of Series A Preferred exceed 3,556,777 shares unless
• | our stockholders approve the issuance of all shares of common stock issuable upon conversion of the Series A Preferred at a meeting duly called for such purpose; | |
• | we obtain permission from NASDAQ to allow such issuance without any limitation on the number of shares of common stock issuable upon conversion of the shares of Series A Preferred; or | |
• | we are no longer governed by a rule promulgated by a stock exchange, NASDAQ, or other applicable body prohibiting the issuance of common stock upon conversion of the Series A Preferred in excess of 19.9% of the number of shares of common stock outstanding without stockholder approval. | |
Immediately upon the satisfaction of any of the conditions listed above, all outstanding shares of Series A Preferred will be converted automatically into the number of shares of common stock into which the shares of Series A Preferred are then convertible as of the date of the satisfaction of such condition. We have agreed with the holders of Series A Preferred that without the consent of a majority in interest of the holders of Series A Preferred, we will not hold a special meeting of stockholders or otherwise seek stockholder approval that would result in mandatory conversion of the common stock.
The shares of Series A Preferred have the right to that number of votes that is equal to the number of shares of common stock issuable upon any permitted conversion of the Series A Preferred, and vote together with the common stock as if a single class.
As a result of the private placement during December 2002, and considering the ability to convert shares of Series A Preferred into 3,556,777 shares of common stock, Mr. Fischer beneficially owns approximately 46.6% of our outstanding common stock.
In the event that Mr. Fischer or Phoenix House participate in this rights offering, we expect that they will purchase shares of common stock by tendering their shares of Series A Preferred. In such event, and depending on the extent to which current stockholders exercise their subscription privileges, Mr. Fischer could beneficially own approximately 55.7% of our common stock.
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Although we expect that Mr. Fischer and Phoenix House will purchase shares of common stock in this rights offering by tendering their shares of Series A Preferred, Mr. Fischer and Phoenix House will be granted equal rights to purchase additional shares of common stock as all other stockholders in this offering. Rather than tender their shares of Series A Preferred, Mr. Fischer and Phoenix House will have the ability to purchase an additional 7,976,140 shares of common stock in addition to the shares of Series A Preferred currently held by them. Although in such event we would receive additional proceeds from the sale of such shares of common stock, and depending on the extent to which current stockholders exercise their subscription privileges, Mr. Fischer would beneficially own up to approximately 66.2% of our common stock, assuming that Mr. Fischer and Phoenix House had the ability to convert all shares of Series A Preferred held by them. In addition, Mr. Fischer and Phoenix House would retain all of the rights and preferences of the Series A Preferred, including dividend rights, liquidation preferences, and other protective provisions. See “Description of Securities — Preferred Stock — Series A Redeemable Convertible Preferred Stock.”
In any event, Mr. Fischer will be able to exercise control over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, which could have the effect of delaying or preventing a change in control of our company. Our certificate of incorporation does provide, however, that the affirmative vote of 80% of our outstanding stock is required to remove any of our directors, to approve a business combination or certain other transactions between our company and a person or entity that beneficially owns 10% of our voting capital stock, or for our stockholders to amend our bylaws or the anti-takeover provisions of our certificate of incorporation.
There is no minimum number of rights that must be exercised in this rights offering.
There is no minimum number of rights that must be exercised in this rights offering before we can accept the net proceeds received. Accordingly, all net proceeds will be made immediately available to us for the purposes set forth in this prospectus. We cannot assure you that any shares of common stock will be sold in this offering. Furthermore, we cannot assure you that the amount of net proceeds received by us from the sale of common stock will be adequate to pay for the costs of this offering or to enable us to pursue our intended operations in the manner or to the extent we contemplate in this prospectus. As a result, you will have a greater risk of loss in the event we are unable to sell a sufficient number of shares of common stock in this rights offering in order to improve our liquidity.
After completion of this rights offering, we will probably need additional authorized shares of common stock to permit additional public or private offerings of equity securities, and our stockholders may not approve such an increase in our authorized common stock.
After completion of this rights offering, we will have only a limited number of authorized but unissued shares of common stock to permit public or private offerings of equity securities. In addition, until such time as we have sufficient authorized shares of common stock, we may be unable to grant options to purchase shares of our common stock to attract and retain officers, directors, or employees. Specifically, if the rights offering is fully subscribed, whether through any combination of basic subscription rights, over subscription rights, or sales to possible new investors, and if Mr. Fischer and Phoenix House purchase shares of common stock for cash in the rights offering, there will be 11,994,628 shares of authorized but unissued shares of common stock available for future issuance of equity securities. Any amendment to our certificate of incorporation to increase the number of authorized shares of common stock will require approval of our board of directors and stockholders. We cannot assure you that our stockholders will approve an amendment to our certificate of incorporation to increase our authorized common stock. Our inability to amend our certificate of incorporation to increase the authorized shares of common stock, or any delay in amending our certificate of incorporation to approve such increase, could impair our ability to raise capital or to attract and retain officers, directors, or employees.
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The price of our common stock may decline before or after the subscription rights expire.
We cannot assure you that the public trading market price of our common stock will not decline after you exercise your subscription rights. If that occurs, you will have committed to buy shares of common stock at a price above the prevailing market price and you will have an immediate unrealized loss. Moreover, we cannot assure you that, following the exercise of subscription rights, you will be able to sell your shares of common stock at a price equal to or greater than the subscription price. Until certificates are delivered upon expiration of this rights offering, you may not be able to sell the shares of our common stock that you purchase in this rights offering. Certificates representing shares of our common stock purchased will be delivered as soon as practicable after expiration of this rights offering. We will not pay you interest on funds delivered to the subscription agent pursuant to the exercise of rights.
Once you exercise your subscription rights, you cannot revoke the exercise.
Once you exercise your subscription rights, you cannot revoke the exercise, even if fewer than all of the shares that we are offering are actually purchased. If we elect to withdraw or terminate this rights offering, neither we nor the subscription agent will have any obligation with respect to the subscription rights except to return, without interest, any subscription payments.
The subscription price is not an indication of the value of our company.
The subscription price per share in this rights offering is equal to the conversion price per share of the Series A Preferred offered and sold in the private placement to Mr. Fischer and Phoenix House during December 2002. During the private placement during December 2002, a special committee of our Board of Directors set the conversion price of the Series A Preferred after considering a variety of factors as described in this prospectus. The subscription price does not necessarily bear any relationship to the book value of our assets, past operations, cash flows, losses, financial condition, or any other established criteria for value, and is not necessarily an indication of the present or future value of our company.
FORWARD-LOOKING STATEMENTS
The statements contained in this prospectus that are not purely historical are forward-looking statements within the meaning of applicable securities laws. Forward-looking statements include statements regarding our “expectations,” “anticipations,” “intentions,” “beliefs,” or “strategies” regarding the future. Forward-looking statements also include statements regarding revenue, margins, expenses, and earnings analysis for fiscal 2002 and thereafter; technological developments; future products or product development; our product and distribution channel development strategies; potential acquisitions or strategic alliances; the success of particular product or marketing programs; and liquidity and anticipated cash needs and availability. All forward-looking statements included in this prospectus are based on information available to us as of the date of this prospectus, and we assume no obligation to update any such forward-looking statements. Our actual results could differ materially from the forward-looking statements. Among the factors that could cause results to differ materially are the factors discussed in “Risk Factors.”
USE OF PROCEEDS
Assuming that stockholders exercise subscription rights for all of the common stock that we are offering, and assuming that Mr. Fischer and Phoenix House exercise their basic subscription rights by tendering shares of Series A Preferred, then we will receive gross proceeds of approximately $4.6 million in this rights offering. Assuming that stockholders exercise with cash subscription rights for all of the common stock we are offering, we will receive gross proceeds from the rights offering of approximately $7.1 million. We will pay estimated expenses of approximately $350,000 in connection with the rights offering.
We intend to use the net proceeds from the rights offering for general working capital purposes and to improve our liquidity.
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There is no minimum number of rights that must be exercised in this rights offering before we can accept the net proceeds received. Accordingly, all net proceeds will be made immediately available to us for the purposes set forth in this prospectus. We cannot assure you that any shares of common stock will be sold in this offering. Furthermore, we cannot assure you that the amount of net proceeds received by us from the sale of common stock will be adequate to pay for the costs of this offering or enable us to pursue our intended operations in the manner or to the extent we contemplate in this prospectus. As a result, you will have a greater risk of loss in the event we are unable to sell a sufficient number of shares of common stock in this rights offering in order to improve our liquidity.
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PRICE RANGE OF COMMON STOCK
Our common stock was quoted in the NASDAQ National Market under the symbol “SMDK” from October 6, 1999 until December 3, 2002 and is now quoted in the NASDAQ SmallCap Market. The following table sets forth the high and low sales prices per share of our common stock on the NASDAQ National Market and the NASDAQ SmallCap Market for the periods indicated.
High | Low | ||||||||
Year ended December 31, 2003: | |||||||||
First Quarter (through January 29, 2003) | $ | 0.48 | $ | 0.36 | |||||
Year ended December 31, 2002: | |||||||||
Fourth Quarter | $ | 0.92 | $ | 0.11 | |||||
Third Quarter | $ | 0.31 | $ | 0.13 | |||||
Second Quarter | $ | 1.80 | $ | 0.25 | |||||
First Quarter | $ | 3.89 | $ | 1.15 | |||||
Year ended December 31, 2001: | |||||||||
Fourth Quarter | $ | 1.79 | $ | 1.10 | |||||
Third Quarter | $ | 4.18 | $ | 1.50 | |||||
Second Quarter | $ | 4.70 | $ | 2.05 | |||||
First Quarter | $ | 7.31 | $ | 2.67 | |||||
Year ended December 31, 2000: | |||||||||
Fourth Quarter | $ | 13.25 | $ | 2.19 | |||||
Third Quarter | $ | 37.00 | $ | 14.38 | |||||
Second Quarter | $ | 36.50 | $ | 16.38 | |||||
First Quarter | $ | 65.13 | $ | 24.13 |
As of January 29, 2003, there were approximately 170 holders of record of our common stock. However, the majority of shares are held by brokers and other institutions on behalf of stockholders; therefore, we are unable to estimate the total number of stockholders represented by these record holders. We believe that there are more than 6,000 beneficial owners of our common stock. On January 29, 2003, the last sale price of our common stock as reported on the NASDAQ SmallCap Market was $0.39 per share.
We have never declared or paid any cash dividends on our common stock. Since we currently intend to retain all future earnings to finance future growth, we do not anticipate paying any cash dividends in the foreseeable future.
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CAPITALIZATION
The following table sets forth (a) our company’s actual capitalization as of September 30, 2002, (b) our pro forma capitalization before this offering to reflect the issuance of 2,552,364.8 shares of Series A Preferred as if the shares had been issued as of September 30, 2002, and (c) our pro forma capitalization as of September 30, 2002, as adjusted to reflect the sale of the maximum number of shares offered in this rights offering at an offering price of $0.32 per share and the application of the estimated net proceeds therefrom, after deducting estimated offering expenses of $350,000.
September 30, 2002 | ||||||||||||||
Pro forma | ||||||||||||||
Actual | Pro forma(1) | as adjusted(2) | ||||||||||||
(In thousands, except share amounts) | ||||||||||||||
Cash and cash equivalents | $ | 2,862 | $ | 5,220 | $ | 9,434 | ||||||||
Restricted cash | 2,107 | 2,107 | 2,107 | |||||||||||
Stockholders’ equity | ||||||||||||||
Series A Redeemable Convertible Preferred stock, $0.001 par value, 2,552,364.8 shares authorized; no shares issued or outstanding, actual; 2,552,364.8 shares issued and outstanding, pro forma; no shares issued and outstanding pro forma as adjusted | — | 3 | — | |||||||||||
Common Stock, $0.001 par value, 60,000,000 shares authorized; 17,783,890 shares outstanding actual and pro forma; 40,013,753 shares outstanding pro forma as adjusted | 18 | 18 | 40 | |||||||||||
Capital in excess of par value | 146,752 | 149,107 | 153,302 | |||||||||||
Treasury stock, 99,789 shares, at cost, actual, pro forma, and pro forma as adjusted | (99 | ) | (99 | ) | (99 | ) | ||||||||
Accumulated other comprehensive loss | (52 | ) | (52 | ) | (52 | ) | ||||||||
Notes receivable from officers/employees | (295 | ) | (295 | ) | (295 | ) | ||||||||
Accumulated deficit | (136,329 | ) | (136,329 | ) | (136,329 | ) | ||||||||
Total stockholders’ equity | $ | 9,995 | $ | 12,353 | $ | 16,567 | ||||||||
(1) | Reflects the sale and issuance by us during December 2002 of the 2,552,364.8 shares of Series A Preferred to Mr. Fischer and Phoenix House for gross proceeds of approximately $2.5 million as if the shares had been issued as of September 30, 2002. Each share of Series A Preferred is convertible into shares of common stock at an initial conversion price of $0.32 per share of common stock such that each share of Series A Preferred is initially convertible into 3.125 shares of common stock. However, in no event may the aggregate number of shares of common stock issuable upon conversion of all shares of Series A Preferred exceed 3,556,777 shares unless certain conditions occur. See “Description of Securities — Preferred Stock — Series A Redeemable Convertible Preferred Stock.” |
(2) | Assumes the purchase by Mr. Fischer and Phoenix House of 7,976,140 shares of common stock in this rights offering through the tendering of all 2,552,364.8 shares of Series A Preferred held by them. Mr. Fischer and Phoenix House will be granted equivalent rights to purchase additional shares of common stock as all other stockholders in this offering. Rather than tender their shares of Series A Preferred, Mr. Fischer and Phoenix House will have the ability to (a) purchase for cash an additional 7,976,140 shares of common stock in addition to the shares of Series A Preferred currently held by them; or (b) decline to participate in the rights offering and retain their shares of Series A Preferred, including all rights and preferences of such shares. If Mr. Fischer and Phoenix House purchase for cash an additional 7,976,140 shares of common stock in this rights offering, our pro forma as adjusted cash and cash equivalents would be $11.986 million. See “Risk Factors — The chairman of our board of directors may have the ability to control our company before and after completion of this rights offering.” |
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SELECTED CONSOLIDATED FINANCIAL DATA
The following selected financial data should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the consolidated financial statements and notes thereto, and other financial information included elsewhere in this prospectus. Our consolidated statements of operations data set forth below for the years ended December 31, 1999, 2000, and 2001 and the consolidated balance sheet data as of December 31, 2000 and 2001 have been derived from our audited consolidated financial statements which are included elsewhere in this prospectus. The consolidated statement of operations data set forth below for the years ended December 31, 1997 and 1998 and the consolidated balance sheet data as of December 31, 1997, 1998, and 1999 have been derived from our audited consolidated financial statements which are not included in this prospectus. The balance sheet data and the statement of operations data as of and for the nine months ended September 30, 2001 and 2002 have been derived from our unaudited financial statements included elsewhere in this prospectus, which we believe have been prepared on the same basis as the audited financial statements and include all adjustments, consisting of normal recurring adjustments, which we consider necessary for a fair presentation of the selected financial data shown.
Nine Months Ended | |||||||||||||||||||||||||||||
Year Ended December 31, | September 30, | ||||||||||||||||||||||||||||
1997 | 1998 | 1999 | 2000 | 2001 | 2001 | 2002 | |||||||||||||||||||||||
(In thousands, except per share amounts) | |||||||||||||||||||||||||||||
Statement of Operations Data: | |||||||||||||||||||||||||||||
Revenues | $ | 893 | $ | 15,323 | $ | 40,319 | $ | 96,722 | $ | 70,161 | $ | 55,260 | $ | 31,065 | |||||||||||||||
Cost of revenues | 301 | 12,600 | 24,820 | 74,039 | 53,719 | 41,695 | 29,039 | ||||||||||||||||||||||
Gross profit (loss) | 592 | 2,723 | 15,499 | 22,683 | 16,442 | 13,565 | 2,026 | ||||||||||||||||||||||
Operating profit (loss)(1) | (4,016 | ) | (5,581 | ) | 1,763 | (30,044 | ) | (82,590 | ) | (74,759 | ) | (16,291 | ) | ||||||||||||||||
Net income (loss) | (3,964 | ) | (5,503 | ) | 958 | (24,238 | ) | (74,604 | ) | (67,828 | ) | (15,744 | ) | ||||||||||||||||
Earnings (loss) per share — basic(2) | (0.51 | ) | (0.68 | ) | 0.09 | (1.44 | ) | (4.25 | ) | (3.88 | ) | (0.89 | ) | ||||||||||||||||
Earnings (loss) per share — diluted(2) | (0.51 | ) | (0.68 | ) | 0.07 | (1.44 | ) | (4.25 | ) | (3.88 | ) | (0.89 | ) | ||||||||||||||||
Balance Sheet Data (at end of period): | |||||||||||||||||||||||||||||
Total assets | 1,607 | 11,136 | 63,444 | 126,309 | 36,078 | 47,799 | 18,914 | ||||||||||||||||||||||
Long-term debt | 645 | 648 | — | — | — | — | — | ||||||||||||||||||||||
Redeemable common stock | — | 9,992 | — | — | — | — | — | ||||||||||||||||||||||
Stockholders’ equity (deficit) | (4,626 | ) | (6,336 | ) | 49,787 | 100,315 | 25,114 | 32,594 | 9,995 |
(1) | Loss in 2000, 2001, and nine months ended September 30, 2002 reflects approximately $24.7 million, $25.9 million, and $3.2 million, respectively, in amortization of goodwill and other acquisition related intangible assets recorded in connection with the VST and Impleo acquisitions. In addition, loss in 2001 and nine months ended September 30, 2002 reflects approximately $43.8 million and $2.7 million, respectively, of impairment charges to reduce the carrying value of goodwill and other acquisition related intangible assets recorded in connection with the VST and Impleo acquisitions. |
(2) | Shares used in computing earnings (loss) per share reflect the retroactive adjustment of outstanding shares related to the mergers of SmartDiskette Limited and SmartDisk Security Corporation into SmartDisk, as well as the one for four reverse stock split completed in August 1999. |
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
The following discussion and analysis should be read in conjunction with the Selected Consolidated Financial Data and our consolidated financial statements and notes thereto, which are contained elsewhere in this prospectus. Except for historical information contained herein, the following discussion contains forward-looking statements that involve risks and uncertainties and other factors that could cause actual results to differ materially. Such risks and uncertainties are discussed under the caption “Risk Factors.”
General
During the first quarter of 2002, we began reporting our operations as one business segment. Previously, we had reported two business segments: personal storage and digital connectivity. Discrete financial information was previously available and reviewed by management to assess operating performance and make decisions regarding the allocation of resources to these segments. The change to a singular business segment was effected to conform to organizational changes made in the management of our business to more effectively report on the deployment and utilization of our assets. The organizational changes leading to the change in reporting included the closing of our Acton, Massachusetts, facility, which allowed us to consolidate previously independent but redundant operations and unify various functions and processes, including, but not limited to sales, marketing, customer and technical support, finance and product development; thereby, allowing the singular presentation of our company in the marketplace where previously we were represented by two distinct companies, namely SmartDisk Corporation and VST Technologies, Inc. As a result, the previous separation, deployment and utilization of assets no longer occurs. Furthermore, our management neither evaluates our company using the previously reported segments nor separately allocates resources to the aforementioned segments.
Critical Accounting Policies and Significant Estimates
The preparation of financial statements and related disclosures in conformity with generally accepted accounting principles and our discussion and analysis of our financial condition and results of operations requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Note 2 of the Notes to Consolidated Financial Statements in our 2001 Form 10-K describes the significant accounting policies and methods used in the preparation of our consolidated financial statements. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates.
We believe the following to be our critical accounting policies. That is, they are both important to the portrayal of our financial condition and results, and they require us to make judgments and estimates about matters that are inherently uncertain.
Revenue Recognition
We recognize product revenues in accordance with Statement of Accounting Bulletin (SAB) No. 101,Revenue Recognition in Financial Statements. We recognize product revenue when title and risk of loss are transferred to customers, which is generally at the time of shipment. Title and risk of loss are transferred when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is reasonably assured. In accordance with local customs, title and risk of loss at our Japanese subsidiary is transferred to the customer upon acceptance of the product by the customer.
For customers that have a right of return, we record a provision for estimated product returns at the time the related revenue is recognized based on historical return rates. For distributors that have a right of return and who have historically returned large amounts of product, we defer recognition of revenue until those distributors have sold the product. We also provide for price protection and other offerings that may occur under programs we have with our customers. If market conditions were to decline, we may take action to
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We account for the licensing of software in accordance with Statement of Position (SOP) 97-2,Software Revenue Recognition, as amended by SOP 98-9,Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered the sales price is fixed or determinable and collectibility is reasonably assured.
Allowance for Doubtful Accounts
We evaluate the collectibility of our accounts receivable based on a combination of factors. In circumstances where we are aware of a specific customer’s inability to meet its financial obligations to us (e.g., bankruptcy filings, substantive downgrading of credit scores), we record a specific allowance for bad debts against amounts due to reduce the net recognized receivable to the amount we reasonably believe will be collected. For all other customers, we recognize provisions for bad debts based on the length of time the receivables are past due. The amount of provision is based on an evaluation of the inherent risk of collectibility at the balance sheet date. If circumstances change (i.e., higher than expected defaults or an unexpected material adverse change in a major customer’s ability to meet its financial obligations to us), our estimates of the recoverability of amounts due could be reduced by a material amount.
Inventory Reserves
We evaluate the need for reserves based on a quarterly review of forecasted demand and market values for our products. Inventory reserves are established to the extent that the cost of the inventory exceeds the estimated market value of the inventory based on assumptions regarding future demand in relation to existing inventory balances and market conditions. Inventory reserves are applied directly to specific items. Short product life cycles are inherent in the high-technology market. Product and technology transitions announced by us or our competitors, delays in the availability of new products, changes in the purchasing patterns of customers and distribution partners, or adverse global economic conditions may materially affect estimates of inventory reserve requirements resulting in additional inventory write-downs.
Results of Operations
Comparison of Nine Months Ended September 30, 2002 and Nine Months Ended September 30, 2001
Revenues
Product revenues include sales of product recognized when title and risk of loss are transferred to customers, which generally occurs at the time of shipment and sales of product recognized to certain distributors, which had been deferred previously, following the distributors’ sale of the products offset by provisions for estimated product returns and other credits.
Total revenues amounted to $31.065 million for the nine months ended September 30, 2002 compared to $55.260 million for the nine months ended September 30, 2001.
The decrease in revenues for the nine month period ended September 30, 2002 over the comparable period in 2001 resulted from a decline in revenue generated from personal storage and digital connectivity products arising from the combined impacts of ongoing weakness in product demand, which resulted in a decrease in product sales volume of 24.4%, competitive market and pricing pressures, which resulted in a decrease in average product sales prices of 24.3%, compounded by continued weakness in the worldwide economy and significantly lower royalty income and license fees.
Product revenues from the sale of personal storage products decreased to approximately $21.4 million for the nine months ended September 30, 2002 compared to approximately $33.0 million for the nine months ended September 30, 2001.
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The decrease in revenues from the sale of personal storage products for the nine months ended September 30, 2002 over the comparable period in 2001 amounting to $11.6 million, is attributable to a decline in demand for our USB-and FireWire-based storage products arising from ongoing weakness in storage product sales and in the selling prices of a number of personal storage products necessary to stimulate product sales. Accordingly, we realized a decrease in the average sales prices of personal storage products of 49.7%. We expect the decline in selling prices, with the consequent impact on revenues, to continue.
Product revenues from the sale of digital connectivity products decreased to approximately $9.7 million for the nine months ended September 30, 2002 compared to approximately $21.3 million for the nine months ended September 20, 2001.
The decrease in revenues from the sale of digital connectivity products for the nine months ended September 30, 2002 over the comparable period in 2001 amounting to $11.6 million is attributable to a decline in sales of FlashPath products to our OEM partners arising from the decrease in the use of the 3.5-inch floppy drive as a flash memory card interface. Specifically, we realized a decrease in sales volume of digital connectivity products of 52.0%. We expect the decline in sales of FlashPath products to continue as consumers move towards devices with higher transfer speeds resulting in lower revenue from digital connectivity products in 2002 than in 2001. As a result, during the three-month period ended September 30, 2002, we announced our decision to discontinue the sale of FlashPath products to OEM partners. Accordingly, we expect revenues from the sale of FlashPath products to substantially decrease in the future.
Royalty income and license fees recognized during the nine months ended September 30, 2002 consist of royalties earned on several of our products. Royalty income and license fees recognized during the nine months ended September 30, 2001 consist of fees earned from a license agreement on our SafeBoot intellectual property. This agreement terminated on June 30, 2001. We currently do not have plans to enter into any licensing agreements.
Cost of Sales
Cost of sales includes the purchased cost of product, packaging, storage, freight, scrap, as well as royalty payments payable on a number of personal storage and digital connectivity products.
Cost of sales decreased to $29.039 million for the nine months ended September 30, 2002 compared to $41.695 million for the nine months ended September 30, 2001.
The decrease in cost of sales is due to lower sales volumes of personal storage and digital connectivity products.
Inventory Write-downs
Inventory write-downs relate to provisions associated with revaluing inventory to net realizable or market value and excess and obsolete inventory.
Inventory write-downs for the nine months ended September 30, 2002 increased to $4.803 million compared to $2.250 million for the nine months ended September 30, 2001.
The inventory write-downs of $4.803 million, recorded in the first quarter of 2002, resulted from and comprise (i) a provision of approximately $3.2 million to reduce the carrying value of a number of personal storage and software products necessitated by a decline in product demand resulting from weakness in product sales and a decline in selling prices experienced during the quarter ended March 31, 2002, (ii) a provision of approximately $1.2 million to cover excess and obsolete product and (iii) a provision of approximately $0.4 million to cover inventory issues in connection with the restructuring of our European facility associated with certain aging legacy storage products. The inventory write-downs of $2.250 million recorded during the nine months ended September 30, 2001 resulted from the necessity to provide for product excess arising from weakness in product sales and obsolescence arising from certain aging legacy storage products.
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Gross Profit (Loss) |
Gross profit for the nine months ended September 30, 2002 was $2.026 million, or a 0.7% of total revenues, compared to $13.565 million, or 24.5% of total revenues, for the nine months ended September 30, 2001.
Excluding the impact of the inventory write-downs, gross profit for the nine months ended September 30, 2002 amounted to $6.829 million, or 22.0% of total revenues compared to $15.815 million, or 28.6% of total revenues, for the nine months ended September 30, 2001.
The decrease in gross profit for the nine months ended September 30, 2002 over the comparable period in 2001 is attributable to the inventory write-downs, the declines in both demand for our products and selling prices resulting from ongoing weakness in storage product sales and decreasing FlashPath product sales to our OEM partners. In addition, the impact of the reduction in carrying values of a number of personal storage and software products will adversely affect the gross profit earned on such reduced carrying value products in future reporting periods from an absolute as well as a percentage of total revenues perspective.
Research and Development Expenses |
Research and development expenses consist primarily of salaries and payroll-related expenses for design and development engineers, as well as prototype supplies and contract or professional services.
Research and development expenses decreased to $1.796 million, or 5.8% of total revenues, for the nine months ended September 30, 2002 compared to $5.818 million, or 10.5% of total revenues, for the nine months ended September 30, 2001.
The decrease in research and development expenses for the nine months ended September 30, 2002 over the comparable period in 2001 is attributable to $1.568 million in cost savings realized following the closing of the Acton, Massachusetts facility, and $2.454 million associated with our business restructuring plan commenced in the quarter ended March 31, 2002 and the move to product outsourcing whereby a third party provides a turnkey product solution to us encompassing both design and manufacturing.
Research and development expenses related to personal storage and digital connectivity products were incurred to support the development of new products, such as the FireLite product range, as well as the maintenance and refresh of existing products.
Sales and Marketing Expenses
Sales and marketing expenses include salaries, benefits and travel expenses for our sales, marketing and product management personnel in the United States, Japan and the United Kingdom. These expenses also include other selling and marketing expenditures for items such as trade shows, advertising, marketing and other promotional programs.
Sales and marketing expenses decreased to $3.910 million, or 12.6% of total revenues, for the nine months ended September 30, 2002 compared to $7.098 million, or 12.8% of total revenues, for the nine months ended September 30, 2001.
The decrease in sales and marketing expenses for the nine months ended September 30, 2002 over the comparable period in 2001 is attributable to $1.604 million in cost savings realized following the closing of the Acton, Massachusetts facility, and $1.584 million associated with our business plan commenced in the quarter ended March 31, 2002 and the consolidation of sales and marketing activities in the U.S. following the Acton facility closure.
General and Administrative Expenses
General and administrative expenses include the salaries and related expenses of our executive management, finance, information systems, operations, human resources, legal and administrative functions,
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General and administrative expenses decreased to $5.846 million, or 18.8% of total revenues, for the nine months ended September 30, 2002 compared to $7.272 million, or 13.2% of total revenues, for the nine months ended September 30, 2001.
The decrease in general and administrative expenses for the nine months ended September 30, 2002 over the comparable period in 2001 is attributable to $1.745 million in cost savings realized following the closing of the Acton, Massachusetts facility and $0.533 million associated with our business restructuring plan commenced in the quarter ended March 31, 2002 offset by an increase in the allowance for doubtful accounts of $0.933 million taken in the quarter ended March 31, 2002 associated with (i) certain aging receivables and (ii) provisions related to the restructuring of our European facility, as compared to comparable allowances for doubtful accounts amounting to $0.061 million in 2001.
Amortization and Depreciation
Amortization includes the amortization of the purchase price allocated to the separately identified intangible assets acquired in the acquisitions of VST Technologies, Inc. and Impleo Limited and from El Gato Software LLC and the amortization of other intangible assets, such as patents and licenses. The separately identified intangible assets acquired in the acquisitions of VST Technologies, Inc. and Impleo Limited and from El Gato Software LLC consist of non-compete agreements, distribution channels, trade names, patents, and workforce in place. These intangible assets have lives ranging from one to ten years from the date of acquisition. Depreciation includes the depreciation of property and equipment.
For the nine months ended September 30, 2002, amortization and depreciation totaled $3.195 million compared to $24.460 million for the nine months ended September 30, 2001.
The decrease in amortization and depreciation for the nine months ended September 30, 2002 over the comparable period in 2001 is attributable to the adoption of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standard (SFAS) No. 142,Goodwill and Other Intangible Assets; whereby, starting on January 1, 2002, purchased goodwill is no longer amortized, and the decrease in the carrying amount of the separately identifiable intangible assets associated with the acquisitions of VST Technologies, Inc. and Impleo Limited due to the impairment write-downs recorded in the three months ended September 30, 2001, December 31, 2002, and March 31, 2002, respectively.
Impairment of Goodwill and Other Intangible Assets
We continually evaluate the recoverability of our goodwill in accordance with SFAS No. 142,Goodwill and Other Intangible Assets. In addition, we continually evaluate the recoverability of our other depreciable intangible assets in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets.
Under SFAS No. 142, goodwill of a reporting unit is tested for impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Examples of such events or circumstances include, but are not limited to, a significant adverse change in legal factors or in the business climate, unanticipated competition and a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of.
Under SFAS No. 142, goodwill is tested for impairment at a level of reporting referred to as a reporting unit. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. A two-step impairment test is used to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized.
The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting
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The second step of the goodwill impairment test, used to measure the amount of impairment loss, compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.
The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in connection with a business combination is determined. That is, the fair value of a reporting unit is allocated to all assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill.
Under SFAS No. 144, an impairment review is performed if events occur or circumstances change indicating that the carrying amount might not be recoverable. Factors considered important which could trigger an impairment review include, but are not limited to, a significant decrease in the market value, a significant adverse change in legal factors or in the business climate, a current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses and a current expectation that more-likely-than-not a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. If any of the impairment indicators are present or if other circumstances indicate that an impairment may exist, we must then determine whether an impairment loss should be recognized. An impairment loss can only be recognized if the undiscounted cash flows used to test for recoverability are less than the carrying value. If we determine that an impairment loss should be recognized, the impairment measured is based on the difference between the fair value and the carrying value.
As a result of the significant decline in the operating results and cash flows of personal storage products and European operations, combined with marginal historical operating and cash flow results, we undertook our impairment reviews. Based on impairment reviews performed at March 31, 2002, in relation to the carrying values of goodwill and other intangible assets recorded in connection with the acquisitions of VST Technologies, Inc. and Impleo Limited, as well as a license obtained from SanDisk Corporation to sell FlashPath for the MultiMediaCard, a $2.729 million impairment charge was provided in the three months ended March 31, 2002 to reduce the carrying value of the aforementioned assets to zero. The fair values used in measuring the impairment charge was determined based upon estimated discounted future cash flows. The assumptions supporting future cash flows, including the discount rate, were determined using our best estimates.
Business Restructuring Charges
In the first quarter of 2002, we began the implementation of a restructuring plan in response to a decline in both demand for our products and the competitive environment in which we operate and recorded a restructuring charge of $0.841 million. The restructuring plan included an involuntary reduction in workforce of 21 employees across all business functions and the curtailment of operating and other expenditures, such as advertising, marketing, tradeshows, contract labor and consulting services, recruiting and traveling. Through September 30, 2002, a total of 33 employees have been terminated, which represents an additional 12 employees over and above the restructuring plan total. As of September 30, 2002, employee separation payments amounted to $0.336 million. The benefit resulting from the reduction in employees and the curtailment of our operating and other expenditures amounts to $8.4 million on an annual basis.
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The elements of the restructuring costs related to the restructuring plan are as follows:
Restructuring | |||||||||||||||||
Non- | Liability at | ||||||||||||||||
Total | cash | Cash | September 30, | ||||||||||||||
Charge | Charges | Payments | 2002 | ||||||||||||||
(In thousands) | |||||||||||||||||
Workforce reduction | $ | 513 | $ | — | $ | (336 | ) | $ | 177 | ||||||||
Facility lease and contract settlement costs | 96 | (46 | ) | — | 50 | ||||||||||||
Write-down of property and equipment, net | 232 | (232 | ) | — | — | ||||||||||||
Total | $ | 841 | $ | (278 | ) | $ | (336 | ) | $ | 227 | |||||||
Facility Closing Costs
On May 31, 2001, we announced our intention to close our Acton, Massachusetts facility and move those operations into our Naples, Florida headquarters. This action allowed us to consolidate previously independent but redundant operations and unify various functions and processes, including, but not limited to sales, marketing, customer and technical support, finance and product development; thereby, allowing the singular presentation of our company in the marketplace where previously we were represented by two distinct companies, SmartDisk Corporation and VST Technologies, Inc. In connection with the closing, which was substantially completed as of September 30, 2001, we recognized $1.173 million and $1.673 million in expenses during the three and nine months ended September 30, 2001, respectively. Total facility closing expenses comprised of $0.644 million in severance costs, $0.530 million in lease cancellation costs and $0.499 million in property and equipment write-downs. The severance costs incurred in association with the closing of the facility related to 20 employees whose positions were eliminated.
Gain (Loss) on Foreign Exchange
Gain (loss) on foreign currency exchange reflects the remeasurement of transactions denominated in currencies other than the local currency of the U.S., Japanese and European operations.
Loss on foreign exchange for the nine months ended September 30, 2002 was $0.471 million compared to a gain of $0.192 million for the nine months ended September 30, 2001.
The loss on foreign exchange for the nine months ended September 30, 2002, resulted from the depreciation of the U.S. dollar vis-à-vis the Japanese yen and British pound arising from trading balances between us and our subsidiaries and amongst and between the subsidiaries.
Interest and Other Income (Expense), net
The primary components of interest and other income or expense are interest earned on cash, cash equivalents and short-term investments and property and equipment write-downs.
Income Tax Benefit
We are subject to tax in Japan, Switzerland, the United Kingdom and the United States. These jurisdictions have different marginal tax rates.
The benefit from income taxes for the nine months ended September 30, 2002, was $1.013 million, compared to $6.035 million for the nine months ended September 30, 2001.
The benefit from income taxes for the nine months ended September 30, 2002 resulted from an income tax expense of $0.104 million offset by income tax benefits of $0.791 million resulting from (i) the amortization expense on certain intangible assets related to the VST and Impleo acquisitions of $0.465 million and (ii) the release of estimates for taxes due which are no longer required to be provided for due to the loss position recorded at certain of our subsidiaries of $0.326 million.
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Comparison of Years Ended December 31, 2001 and 2000
Revenues |
Total product revenues were approximately $69.3 million for the year ended December 31, 2001 compared to approximately $94.3 million for the year ended December 31, 2000. This decrease was primarily attributable to a decline in demand for our products arising from the anticipated decline in the use of the 3.5-inch floppy drive as a flash memory card interface, a decline in demand for expansion bay products due to the redesign of Apple laptop computers, which no longer contain expansion bay capabilities, a continued weakness in the worldwide economy and a decline in research and development revenue.
Our product revenues from the sale of personal storage products decreased to approximately $43.8 million for the year ended December 31, 2001 compared to approximately $49.8 million for the period from March 6, 2000, the date we acquired VST, through December 31, 2000. This decrease is primarily attributable to a decline in demand for our USB- and FireWire-based products arising from the continued weakness in the worldwide economy, as well as a decline in demand for expansion bay products due to the redesign of Apple laptop computers, which no longer have expansion bay capabilities. In addition we decreased the sale prices of various personal storage products during the year in order to stimulate market demand.
Our product revenues from the sale of digital connectivity products decreased to approximately $25.4 million for the year ended December 31, 2001 compared to approximately $44.5 million for the year ended December 31, 2000. This decrease is primarily attributable to the decline in the use of the 3.5-inch floppy drive as a flash memory card interface, as consumers move toward devices with higher data transfer rates, such as our USB-based flash media readers. In addition, demand for our products declined as a result of the continued weakness in the worldwide economy. Both of these factors are contributing to the decline in our FlashPath products.
Our revenues from research and development agreements were approximately $0.1 million for the year ended December 31, 2001 compared to approximately $1.3 million for the year ended December 31, 2000. This decrease is primarily attributable to a decline in new research and development agreements during the year. We earned the significant portion of our research and development revenues in 2001 from a research and development agreement, which was completed during the quarter ended June 30, 2001.
Our revenues from license fees and royalty agreements were approximately $0.8 million for the year ended December 31, 2001 compared to approximately $1.1 million for the year ended December 31, 2000. This decrease is primarily attributable to the expiration of the license agreement in 2001 and purchase of the SafeBoot intellectual property by the licensee. These revenues represent less than two percent of our total revenues for the year ended December 31, 2001.
Cost of Revenues |
Cost of revenues were approximately $53.7 million for the year ended December 31, 2001 compared to approximately $74.0 million for the year ended December 31, 2000. This decrease in cost was due primarily to lower sales volume of our FlashPath products and certain personal storage products, offset in part by inventory writedowns of aging products of approximately $3.0 million.
Our cost of revenues from the sales of personal storage products decreased to approximately $36.1 million for the year ended December 31, 2001 compared to approximately $43.6 million for the period from March��6, 2000, the date we acquired VST, through December 31, 2000. This decrease is primarily attributable to the decrease in sales volume of our personal storage products due to a decline in demand, which was offset in part by approximately $2.3 million of inventory writedowns during the year arising from the decrease in demand for certain legacy storage products.
Our cost of revenues from the sales of digital connectivity products decreased to approximately $17.3 million for the year ended December 31, 2001 compared to approximately $30.1 million for the year ended December 31, 2000. This decrease is primarily attributable to the decline in demand for our FlashPath
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Gross Profit |
Our gross profit for the year ended December 31, 2001 decreased to approximately $16.4 million, or 23% of total revenue, compared to approximately $22.7 million, or 23% of total revenue, for the year ended December 31, 2000. This decrease in the amount of gross profit is primarily attributable to declines in sales arising from declines in demand for our FlashPath products and various aging personal storage products with declining margins and the decrease in research and development revenue. In addition, we recognized inventory writedowns, associated with our connectivity products and aging legacy storage products, which decreased the amount of gross profit by approximately $3.0 million and the gross margin percentage from approximately 28% to the reported 23%.
Our gross profit from sales of personal storage products for the year ended December 31, 2001 increased to approximately $7.7 million, or 18% of personal storage revenue, compared to approximately $6.2 million, or 12% of personal storage revenue, for the period from March 6, 2000, the date we acquired VST, through December 31, 2000. Our gross profit decreased in 2001 due to a decline in demand for our storage products and inventory writedowns associated with our aging legacy storage products. This decrease was offset by lower writedowns of inventory in 2001 as compared to 2000. In 2001, our inventory writedowns were approximately $2.3 million as compared to approximately $7.3 million in 2000. Excluding the inventory writedowns, the margins on our personal storage products would have been approximately 23% in 2001 and approximately 27% in 2000.
Our gross profit from sales of digital connectivity products for the year ended December 31, 2001 decreased to approximately $8.1 million, or 32% of digital connectivity revenue, compared to approximately $14.4 million, or 32% of digital connectivity revenue, for the year ended December 31, 2000. This decrease was primarily attributable to a decrease in demand for our FlashPath products resulting from the anticipated decline in the use of the 3.5-inch floppy drive as a flash memory card interface and inventory writedowns of approximately $0.7 million associated with our FlashPath for MultiMedia Card product due to our discontinuance of that product.
Research and Development Expenses |
Research and development expenses decreased to approximately $7.7 million, or 11% of total revenues, for the year ended December 31, 2001 compared to approximately $9.2 million, or 9% of total revenues, for the year ended December 31, 2000. This decrease in expenditures was primarily attributable to approximately $0.8 million in cost savings realized due to the closing of our Acton, Massachusetts operation as well as approximately $0.7 million in other actions taken to control or reduce operating expenses.
Research and development expenses related to our personal storage products were primarily incurred for the development of our new FireFly and FireLite line of hard disk drive products, and our FireWire 8X CD-R/W product. Research and development expenses related to digital connectivity products were incurred to support the development of our USB Flash Media Readers as well as the maintenance of existing products. In addition, research and development expenses were incurred in support of the development of our MVP software product and our DVD authoring products.
Sales and Marketing Expenses |
Sales and marketing expenses increased to approximately $9.2 million for the year ended December 31, 2001 compared to $6.6 million for the year ended December 31, 2000. The increase in expenditures was primarily attributable to an increase in marketing and sales personnel to support the launch of new products and the broadening of our distribution into more traditional consumer electronic and mass retail channels, an increase in advertising and promotional programs in support of our MVP software product and the inclusion of VST’s results for the twelve months ended December 31, 2001 compared to the period from March 6, 2000 to
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General and Administrative Expenses |
General and administrative expenses increased to approximately $12.5 million for the year ended December 31,2001 compared to approximately $12.3 million for the year ended December 31, 2000. This increase was primarily attributable to the inclusion of VST’s results for the twelve months ended December 31, 2001 compared to the period from March 6, 2000 to December 31, 2000 in the preceding year and integration expenses associated with the closing of our Acton, Massachusetts facility and the relocation of those operations into our Naples, Florida headquarters. This increase was offset in part by approximately $1.1 million in cost savings realized due to the closing of our Acton, Massachusetts operation. During the year ended December 31, 2001, we recognized non-recurring expenses of approximately $1.7 million for costs associated with the closing of our Acton, Massachusetts operation, including employee severance, buyout of a facility lease and disposal of property and equipment.
Amortization of Goodwill and Other Acquisition Related Intangible Assets |
As of December 31, 2000, our intangible assets primarily consisted of goodwill and separately identified intangible assets recognized in connection with our acquisitions completed in 2000, which were recorded under the purchase method of accounting. The separately identified intangible assets acquired consist of non-compete agreements, distribution channels, trade names, patents and workforce in place. These intangible assets have lives ranging from one to five years from the date of acquisition. Purchase price not allocated to separately identified intangible assets was allocated to goodwill. Goodwill is amortized over a five-year life from the date of acquisition. For the year ended December 31, 2001, amortization of goodwill and other acquisition related intangible assets totaled approximately $25.9 million compared to approximately $24.7 million for the year ended December 31, 2000. This increase was primarily attributable to the inclusion of the amortization associated with the acquisition of VST and Impleo for the twelve months ended December 31, 2001 compared to the period from March 6, 2000 to December 31, 2000 for VST and April 28, 2000 to December 31, 2000 for Impleo, which was partially offset by a reduction in fourth quarter amortization due to the recording of an impairment writedown of the goodwill and other acquisition related intangible assets recorded in connection with the VST acquisition.
Impairment of Goodwill and Other Acquisition Related Intangible Assets |
We continually evaluate the recoverability of our long-lived assets, such as goodwill and other acquisition related intangible assets, in accordance with Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important which could trigger an impairment review include, but are not limited to, significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the overall business, a significant decline in the stock price for a sustained period, the market capitalization relative to net book value and significant negative industry or economic trends which indicate that this trend may continue for an indefinite period of time. If we determine that the carrying value may not be recoverable based upon the existence of one or more of the above indicators of impairment, any impairment measured is based on a projected discounted cash flow method using a discount rate commensurate with the risk inherent in our current business model.
Based on the impairment review performed for the quarter ended September 30, 2001, we recorded a $42.0 million impairment charge to reduce goodwill and other acquisition related intangible assets recorded in connection with the VST acquisition. In addition, based on the impairment review performed for the quarter ended December 31, 2001, we recorded a $1.8 million impairment charge to reduce goodwill and other acquisition related intangible assets recorded in connection with the Impleo acquisition. These charges were
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Closing of Acton Facility |
On May 31, 2001, we announced our intention to close our Acton, Massachusetts facility and move those operations into our Naples, Florida headquarters. This closing allowed us to centralize our operations and marketing and development efforts, improve operational efficiencies and otherwise increase the effectiveness of our business. In connection with this closing, we recognized expenses of approximately $1.7 million during the year ended December 31, 2001. Total closing expenses were comprised of approximately $0.6 million in severance costs recorded as operating expenses, approximately $0.6 million in lease cancellation costs recorded in general and administrative expenses and approximately $0.5 in property and equipment writedowns recorded in other expenses.
Gain on Foreign Exchange |
Gain on foreign exchange increased to approximately $0.7 million for the year ended December 31, 2001 compared to approximately $0.3 million for the year ended December 31, 2000. This increase is primarily due to the effect of the devaluation of the Japanese yen and the British pound versus the U.S. dollar during the period on the remeasurement of U.S. dollar denominated receivables.
Interest and Other Income, net |
Interest and other income, net decreased to approximately $0.3 million for the year ended December 31, 2001 compared to approximately $1.5 million for the year ended December 31, 2000. The primary components of interest and other income, net, are interest earned on cash, cash equivalents and short-term investments and gains or losses on the disposal of property and equipment. The most significant component of these items, for the year ended December 31, 2001, was interest earned on cash, cash equivalents, and short-term investments, which was approximately $0.5 million compared to approximately $1.4 million for the year ended December 31, 2000. This decrease in interest income is due to a reduction in cash, cash equivalents and short-term investments due to cash used during the year and lower interest rates earned on cash, cash equivalents and short-term investments arising from reductions in the Federal Funds Rate established by the Federal Open Market Committee during 2001. In addition, during 2001, we recorded a gain of approximately $0.2 million due to the sale of the SafeBoot intellectual property by the licensee. These items were offset by approximately $0.5 million in property and equipment writedowns associated with the closing of our Acton, Massachusetts facility.
Interest Expense |
Interest expense is incurred on the lines of credit in Japan and the United Kingdom. Interest expense for the year ended December 31, 2001 decreased by approximately $0.1 million compared to the year ended December 31, 2000. This decrease was attributable to a repayment of a large portion of the bank line of credit in Japan, resulting from a decrease in accounts receivable, which represents the borrowing base for the credit facility.
Income Tax Expense (Benefit) |
We are subject to tax in the United States, Japan, Switzerland and the United Kingdom. These jurisdictions have different marginal tax rates. For the year ended December 31, 2001, income tax benefit totaled approximately $7.1 million compared to approximately $4.1 million for the year ended December 31, 2000. The 2001 amount consisted of income tax benefits of approximately $7.7 million primarily resulting from amortization expense on certain intangible assets related to the VST and Impleo acquisitions partially offset by approximately $0.6 million of expense. Due to the treatment of the identifiable intangible assets under SFAS No. 109, Accounting for Income Taxes, we have a net deferred tax liability of approximately $0.8 million as of December 31, 2001. Based on our limited operating history and the cumulative losses from
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Comparison of Years Ended December 31, 2000 and 1999
Revenues |
Total product revenues were approximately $94.3 million for the year ended December 31, 2000 compared to approximately $37.3 million for the year ended December 31, 1999. This increase was primarily attributable to sales of personal storage products subsequent to the acquisition of VST in March 2000 and an increase in sales of our digital connectivity products.
For the period from March 6, 2000, the date we acquired VST, through December 31, 2000, revenues from personal storage products were approximately $49.8 million. Sales of personal storage products declined in the fourth quarter of 2000, primarily attributable to a decrease in sales of our USB- and FireWire-based personal storage products for the Apple market resulting from a decrease in demand for that market.
Our product revenues from the sale of digital connectivity products increased to approximately $44.5 million for the year ended December 31, 2000 compared to approximately $37.3 million for the year ended December 31, 1999. This increase was primarily attributable to the increase in sales of our FlashPath products of approximately $4.1 million.
We earned the significant portion of our research and development revenues from a research and development agreement, which was completed during the quarter ended March 31, 2000. Our total revenues from research and development agreements were approximately $1.3 million for the year ended December 31, 2000 compared to approximately $2.6 million for the year ended December 31, 1999.
Our license fees and royalty revenues represent less than two percent of our total revenues for the year ended December 31, 2000.
Cost of Revenues |
Cost of revenues were approximately $74.0 million for the year ended December 31, 2000 compared to approximately $24.8 million for the year ended December 31, 1999. This increase in cost was due primarily to sales of personal storage products subsequent to the acquisition of VST and an increase in sales of our digital connectivity products.
For the period from March 6, 2000, the date we acquired VST, through December 31, 2000, cost of revenues from sales of personal storage products was approximately $43.6 million. This amount includes approximately $5.2 million of inventory writedowns in the fourth quarter arising from a decrease in demand for personal storage products.
Our cost of revenues from the sales of digital connectivity products increased to approximately $30.1 million for the year ended December 31, 2000 compared to approximately $24.8 million for the year ended December 31, 1999. This increase is primarily attributable to the increase in sales volume of our digital connectivity products. In addition, part of this increase is due to inventory writedowns of approximately $0.5 million associated with our Smarty smart card reader due to our discontinuance of that product line.
Gross Profit |
Our gross profit for the year ended December 31, 2000 increased to approximately $22.7 million, or 23% of total revenue, compared to approximately $15.5 million, or 38% of total revenue, for the year ended December 31, 1999. This increase in the amount of gross profit is primarily attributable to sales of personal storage products subsequent to the acquisition of VST in March 2000, which also contributed to the decrease in our gross margin percentage since the gross margin on personal storage products is typically less than on digital connectivity products. In addition, we recognized inventory writedowns primarily on our personal
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For the period from March 6, 2000, the date we acquired VST, through December 31, 2000, gross profit from sales of personal storage products was approximately $6.2 million, or 12% of personal storage revenue. This amount includes inventory writedowns in the fourth quarter arising from a decrease in demand for personal storage products. Excluding the inventory writedowns, the margins on our personal storage products would have been approximately 23%.
Our gross profit from sales of digital connectivity products for the year ended December 31, 2000 decreased to approximately $14.4 million, or 32% of digital connectivity revenue, compared to approximately $12.5 million, or 34% of digital connectivity revenue, for the year ended December 31, 1999. This decrease was primarily attributable to inventory writedowns associated with our Smarty smart card reader due to our discontinuance of that product line.
Research and Development Expenses |
Our research and development expenses increased to approximately $9.2 million, or 9% of total revenues, for the year ended December 31, 2000 compared to approximately $5.9 million, or 15% of total revenues, for the year ended December 31, 1999. This increase in expenditures was primarily attributable to the acquisition of VST, as well as hiring additional technical personnel, including salaries and related payroll expenses, costs incurred in conjunction with our research and development contracts and the outsourcing of product development.
Research and development expenses related to digital connectivity products were incurred to support the development of our USB Flash Media Reader, other products to transfer digital content from flash memory cards to non-PC technologies and enhanced versions of our FlashPath products. Research and development expenses related to our personal storage products were incurred for the development of our USB/ FireWire combo hard disk drive for Windows, a bus powered FireWire CD-R/W and higher capacity thin FireWire hard disk drives.
Sales and Marketing Expenses |
Sales and marketing expenses increased to approximately $6.6 million for the year ended December 31, 2000 compared to $1.6 million for the year ended December 31, 1999. The change from 1999 to 2000 was primarily attributable to the acquisition of VST and Impleo. With the acquisition of VST in March 2000 and the acquisition of Impleo in April 2000, we added a number of new products to our existing product lines, significantly increasing our total sales and marketing expenses. These added products required more catalog and magazine advertising than we have needed in the past due to our OEM relationships.
General and Administrative Expenses |
General and administrative expenses increased to approximately $12.3 million for the year ended December 31, 2000 compared to approximately $6.3 million for the year ended December 31, 1999. This increase is primarily attributable to the acquisitions of VST and Impleo, as well as increases in depreciation and amortization, professional services, and legal and accounting fees. During the year ended December 31, 2000, we recognized non-recurring expenses of approximately $1.1 million for costs associated with a withdrawn secondary stock offering, employee severance and the forgiveness of a note receivable.
Amortization of Goodwill and Other Acquisition Related Intangible Assets |
For the year ended December 31, 2000, amortization of goodwill and other acquisition related intangible assets totaled approximately $24.7 million.
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Gain on Foreign Exchange |
Gain on foreign exchange increased to approximately $0.3 million for the year ended December 31, 2000 compared to less than $0.1 million for the year ended December 31, 1999. This increase is primarily due to the effect of the devaluation of the Japanese yen and the British pound versus the U.S. dollar during the period on the remeasurement of U.S. dollar denominated receivables.
Interest and Other Income, net |
Interest and other income, net increased to approximately $1.5 million for the year ended December 31, 2000 compared to approximately $0.5 million for the year ended December 31, 1999. The primary components of interest and other income, net, are interest earned on cash, cash equivalents and short-term investments, gains or losses on the disposal of property and equipment and gains or losses on foreign exchange. The most significant component of these items, for the year ended December 31, 2000, was interest earned on cash, cash equivalents, and short-term investments, which was approximately $1.4 million compared to approximately $0.6 million for the year ended December 31, 1999. This increase in interest income is due to a full year of interest earned on the proceeds from our initial public offering, or IPO, in October 1999, less net proceeds primarily used for acquisitions.
Interest Expense |
Interest expense is incurred on the bank line of credit in Japan and the United Kingdom. We also incurred interest expense on VST’s line of credit until it was paid in full on March 31, 2000. Interest expense for the year ended December 31, 2000 remained consistent at approximately $0.1 million compared to the year ended December 31, 1999.
Income Tax Expense (Benefit) |
For the year ended December 31, 2000, income tax benefit totaled approximately $4.1 million. This amount consisted of income tax benefits of approximately $5.5 million primarily resulting from amortization expense on certain intangible assets related to the VST and Impleo acquisitions partially offset by approximately $1.4 million of expense.
Liquidity and Capital Resources
Cash and cash equivalents decreased to $2.862 million at September 30, 2002 from $14.517 million at December 31, 2001. Cash and cash equivalents have decreased over each of the last several quarters. We have minimal financial resources, and our cash flow from operating activities continues to be insufficient to meet our operating needs and other payment obligations.
The decrease in cash and cash equivalents of $11.655 million reflected (i) net cash in operating activities of $9.533 million, (ii) net cash used in investing and financing activities of $2.227 million and (iii) the positive effect of exchange rate fluctuation on cash of $0.105 million.
Net cash used in operating activities was $9.533 million for the nine months ended September 30, 2002 compared to $2.471 million for the nine months ended September 30, 2001.
Net cash used in operating activities of $9.533 million in the nine months ended September 30, 2002 was comprised of (i) the net cash loss, or net loss adjusted for non-cash charges and credits, of $1,960 million and (ii) investment in working capital of $7.573 million.
The investment in working capital of $7.573 million is comprised of (i) an increase in accounts receivable of $2.382 million, resulting from the concentration of sales in the latter part of the reporting period, (ii) an increase in inventory of $3.158 million, resulting from weakness in storage product sales of $1.120 million and increasing product requirements resulting from products introduced in 2002, such as our FireLite portable hard disk drives product portfolio, film scanners and accessory packs for digital cameras, of $2.038 million, (iii) an increase in prepaid expenses and other current assets, in the normal course of business, of $0.824
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Net cash used in investing activities was $2.166 million for the nine months ended September 30, 2002 compared to net cash provided by investing activities of $1.024 million for the nine months ended September 30, 2001.
The increase in net cash used in investing activities of $3.190 million resulted from an increase in restricted cash of $2.107 million as compared to the release of restricted cash of $1.671 million, the absence of activity in sales and maturities of short-term investments of $6.007 million and in the purchases of short-term investments of $5.600 million and a reduction in fixed asset investment of $0.995 million. The increase in restricted cash of $2.107 million in the nine month period to September 30, 2002 is due to the cash collateralization with our bankers of commercial and standby letters of credit issued to certain of our vendors and as a consequence we do not have access to the cash collateral for as long as the commercial and standby letter of credit exist.
Net cash used in financing activities was $0.061 million and $0.746 million for the nine months ended September 30, 2002 and 2001, respectively.
The decrease in net cash used in financing activities was primarily due to the repayment and termination of our lines of credit and reduced proceeds for the exercise of stock options.
At September 30, 2002, we had $2.107 million in commercial and standby letters of credit outstanding, which were issued to certain vendors. Commercial letters of credit will be paid by our bank in accordance with the terms of the letters of credit. Vendors holding standby letters of credit will not draw against the standby letters of credit as long as vendor invoices are paid within established credit terms. As of September 30, 2002, none of the standby letters of credit had been drawn on.
At December 31, 2002, we did not have any commercial letters of credit outstanding. From time to time, we may issue commercial letters of credit to certain vendors that will be paid by our bank in accordance with the terms of the letters of credit. Any commercial letters of credit will be cash collateralized with our bankers, and as a consequence we will not have access to the cash collateral for as long as the commercial letters of credit exist.
As part of our efforts to improve our liquidity and financial condition, during December 2002, we completed a private placement to Addison Fischer, the Chairman of our Board of Directors, and Phoenix House Investments, LP, an entity controlled by Mr. Fischer, who purchased from us an aggregate of 2,552,364.8 shares of our Series A Redeemable Convertible Preferred Stock for gross proceeds of approximately $2.5 million. After giving effect to this investment and the implementation of our restructuring plan, and based on our current forecasted operations, we believe that our cash and cash equivalents and working capital will be sufficient to meet our operating requirements through December 31, 2003. However, we may be required to reduce our operations or to obtain additional financing if our forecast proves inaccurate for any reason, including the following:
• | our revenue fails to meet our forecast and continues to decline; | |
• | our gross profit fails to meet our forecast and continues to erode; | |
• | our operating expenses exceed our forecast; | |
• | cash is required to collateralize letters of credit for issue to vendors or to prepay vendors for the supply of products or services; | |
• | cash flow from accounts receivable is reduced further or interrupted by slow collections or product returns; | |
• | procurement of inventory exceeds market demand; | |
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• | purchase orders issued for the procurement of inventory in excess of market demand cannot be cancelled with the consequent negative impact on cash; | |
• | vendors unilaterally change the payment terms under which they will supply product or services to us; or | |
• | unanticipated events adversely effect our operations or cash flows. | |
In addition, our continued viability beyond December 31, 2003 will depend upon our ability to generate cash from operations or to obtain additional working capital. Such additional capital, if required, may not be available to us or may be available on terms that may be unacceptable to us. These liquidity problems, among others, raise substantial doubt about whether we can continue as a going concern.
Recent Accounting Pronouncements
Effective January 1, 2002, we adopted SFAS No. 141,Business Combinations. SFAS No. 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting and broadens the criteria for recording intangible assets apart from goodwill. We evaluated our goodwill and other intangibles acquired prior to June 30, 2001 using the SFAS No. 141 criteria. This evaluation did not result in any reclassification between other intangible assets and goodwill at January 1, 2002. The adoption of SFAS No. 141 did not have a material impact on our financial position, results of operations or cash flows, but it will impact the accounting treatment of any future acquisitions.
Effective January 1, 2002, we adopted SFAS No. 142,Goodwill and Other Intangible Assets. SFAS No. 142 requires that purchased goodwill and certain indefinite-lived intangibles no longer be amortized, but instead be tested for impairment at least annually, or more frequently as impairment indicators arise, in accordance with SFAS No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. We evaluated our intangible assets and believe that all such assets have determinable lives. If SFAS No. 142 had been in effect during the three and nine months ended September 30, 2001, our net loss would have been reduced by approximately $2.4 million, or $0.14 per share and approximately $7.3 million, or $0.42 per share, respectively.
Effective January 1, 2002, we adopted SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. SFAS No. 144 applies to all long-lived assets (including discontinued operations) and consequently amends APB Opinion No. 30,Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144 develops one accounting model for long lived assets that are to be disposed of by sale. SFAS No. 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. The adoption of SFAS No. 144 did not have a material impact on our financial position, results of operations or cash flows.
In April 2002, the FASB issued SFAS No. 145,Rescission of FASB Statements Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 eliminates SFAS No. 4,Reporting Gains and Losses from Extinguishment of Debt, (and SFAS No. 64,Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements, as it amends SFAS No. 4), which requires gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of the related income tax effect. As a result, the criteria in APB Opinion No. 30 will now be used to classify those gains and losses. SFAS No. 145 amends SFAS No. 13,Accounting for Leases, to require that certain lease modifications that have economic effects similar to sale-leaseback transactions are accounted for in the same manner as sale-leaseback transactions. This amendment is consistent with the FASB’s goal of requiring similar accounting treatment for transactions that have similar economic effects. In addition, SFAS No. 145 makes technical corrections to existing pronouncements. While those corrections are not substantive in nature, in
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In June 2002, the FASB issued SFAS No. 146,Accounting for Exit or Disposal Activities, effective for exit or disposal activities that are initiated after December 31, 2002, with early adoption encouraged. SFAS No. 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for pursuant to the guidance that the Emerging Issues Task Force (“EITF”) has set forth in EITF Issue No. 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs incurred in a Restructuring). A fundamental conclusion reached by the Board in this statement is that an entity’s commitment to a plan, by itself, does not create a present obligation to others that meets the definition of a liability. Therefore, this SFAS eliminates the definition and requirements for recognition of exit costs in EITF Issue No. 94-3. This statement also establishes that fair value is the objective for initial measurement of the liability. The scope of SFAS No. 146 also includes (1) costs related to terminating a contract that is not a capital lease and (2) termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement or an individual deferred-compensation contract. We do not expect the implementation of this standard to have a material impact on our financial condition, results of operations or cash flows.
Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk. Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. The primary objective of our investment activities is to preserve our invested funds while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we have invested in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline in value. If market interest rates were to increase immediately and uniformly by 10 percent from levels at September 30, 2002, this would not materially change the fair market value of our portfolio. To minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities including U.S. government and government agency notes, corporate bonds and money market funds. In general, money market funds are not subject to interest rate risk because the interest paid on such funds fluctuates with the prevailing interest rate. During the six months ended June 30, 2002, our investment portfolio included marketable securities with contractual maturities of less than one year and active secondary or resale markets to ensure portfolio liquidity.
As of September 30, 2002, we did not hold amounts of cash equivalents and short-term investments that were subject to market risk.
We do not currently hold or issue derivative securities, derivative commodity instruments or other financial instruments for trading purposes.
Foreign Exchange Risk. We conduct operations and sell products in several different countries. Some balance sheet accounts of our U.S., Japanese and European operations are denominated in currencies other than the respective local currency and are remeasured to the respective local currency at the end of the accounting period. This remeasurement results in an adjustment to income. Additionally, the balance sheet accounts of our Japanese and European operations are translated to U.S. dollars for financial reporting purposes and resulting adjustments are made to stockholders’ equity. The value of the respective local currency may strengthen or weaken against the U.S. dollar, which would impact the value of stockholders’ investment in our common stock. Fluctuations in the value of the Japanese yen and the British pound against the U.S. dollar have occurred in 2002. For the nine months ended September 30, 2002, such fluctuations resulted in an accumulated unrealized foreign currency translation gain of approximately $0.583 million which is included in accumulated other comprehensive loss and shown in the equity section of our balance sheet.
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While most of the transactions of our U.S., Japanese and European operations are denominated in the respective local currency, some transactions are denominated in other currencies. Since the accounting records of our foreign operations are kept in the respective local currency, any transactions denominated in other currencies are accounted for in the respective local currency at the time of the transaction. Upon settlement of such a transaction, any foreign currency gain or loss results in an adjustment to income.
Our operating results may be impacted by the fluctuating exchange rates of foreign currencies, especially the Japanese yen and the British pound, in relation to the U.S. dollar. Most of the revenue and expense items of our Japanese and European subsidiaries are denominated in the respective local currency. In both regions, we believe this serves as a natural hedge against exchange rate fluctuations because although an unfavorable change in the exchange rate of the foreign currency against the U.S. dollar will result in lower revenues when translated into U.S. dollars, operating expenses will also be lower in these circumstances. For example, during the nine months ended September 30, 2002, a decrease in the Japanese yen to U.S. dollar of 10 percent would have resulted in a decrease in revenues of approximately $0.5 million and an increase in the net loss before income tax of approximately $0.1 million. Further, a decrease in the British pound to U.S. dollar of 10 percent would have resulted in a decrease in revenues of approximately $0.3 million and a decrease in the net loss before income tax of approximately $0.1 million.
We do not currently engage in hedging activities with respect to our foreign currency exposure; however, we continually monitor our exposure to currency fluctuations. We have not incurred significant realized losses on exchange transactions. If realized losses on foreign transactions were to become significant, we would evaluate appropriate strategies, including the possible use of foreign exchange contracts, to reduce such losses.
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BUSINESS
We develop, manufacture and market a range of advanced consumer electronic products and software solutions that are designed to simplify the use of digital products. Our products help users transfer, store, manage, and share digital music, video, pictures, and data. Headquartered in the United States, with operations in Europe and Asia, we sell and support our products worldwide.
Our Company
Opportunity
We believe that rapid technology advances, consumer appetites for all things digital, and a worldwide economy increasingly dependent on computers and the Internet have created significant opportunity for us:
• | The digital lifestyle market is young and rapidly growing. | |
• | Consumers seek complete solutions to manage and enjoy living a digital lifestyle. | |
• | Our existing products are known for their innovative designs and their reliability. |
Solution
We provide comprehensive devices and software solutions for moving, managing, creating and storing digital content among digital appliances, personal computers, and the Internet. Our products include external portable hard disk drives and floppy disk drives for desktop and notebook personal computers, external CD read/write recorders, flash memory card readers, scanners and CD creation software. Our products are generally available for both Windows and Macintosh operating systems, allowing the OEMs and retailers that market our products to reach a large installed base of potential users. Our products are designed to offer the following principal benefits:
Design.We emphasize innovative product designs that are both attractive and that enhance usability. Our flash memory readers, for example, feature an upright, ergonomic design that allow users to insert and eject media with just one hand. Our FireFly and FireLite portable external hard disk drives feature aesthetically pleasing industrial designs.
Portability.We place a premium on features that allow users to carry and use our products in a variety of settings. These features include compact designs, no requirement for a power adapter and no requirement for installed software drivers. We also offer carry cases that protect our products and make them easier to transport.
Ease of Use.Our products are easy to use and install. Our personal storage systems address the storage needs of today’s consumers: portability, user friendliness, reliability and seamless integration with computer operating systems. These storage devices also offer our proprietary software that enhances the user’s experience, further differentiating our products from competitors’ offerings.
Our FlashPath floppy disk adapter and flash media readers allow the consumer to conveniently transfer digital content from a digital camera or other appliance to a personal computer by simply inserting the flash memory card in the reader and copying its contents to the computer. The interface standard supported by our flash media readers eliminates any driver software for most of today’s Windows and Macintosh operating systems. Unlike other products, our flash memory products do not rely upon a digital appliance’s power source to transfer digital data from a flash memory card to a computer. For example, our media readers are powered by the personal computer. This is important because digital appliances, such as digital cameras, consume significant amounts of power and require frequent battery replacement or recharging. Products that use traditional cable interfaces quickly drain power from digital appliances, making those competing products less attractive. Also, consumers find portable products much more convenient to use if those products don’t require batteries or A/C adapters.
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Our software products allow users to compose slide or video shows and CDs, and play them with or away from a computer, by way of on-screen menus and help guides which enable the user to utilize the software with no formal training.
Versatility.Our products can be used with a variety of different computer hardware and software. As a result, the same media reader that is used to transfer images from one digital camera to a Microsoft-based computer can be used to transfer images from another digital camera to an Apple computer. Similarly, the same media reader that is used to transfer images may also be used to transfer voice and other digital data from a variety of digital appliances that use the same flash memory card. Our personal storage systems are also compatible with both Windows and Macintosh operating systems.
Compatibility.We offer storage devices that are compatible with different computer systems. We offer flash memory cards for all of the leading flash media card formats. Our software products support an extensive array of technical standards for audio, data, enhanced music and video formats for authoring to CDs.
Quality.We believe that we have a reputation in the industry for producing high quality products. We have invested substantial resources in our product quality and test efforts to assure that our products work reliably across a broad range of configurations.
Business Strategy
Our strategy is to:
• | bring hardware products quickly to market with innovative solutions that emphasize modern design, portability and ease of use and that capitalize on our core competencies; | |
• | introduce and acquire innovative, complementary software products to create, manage and use multimedia presentations on computers that can be viewed on digital and/or non-digital appliances; and | |
• | leverage the distributor, retail and Internet channels of distribution and OEM partners we have established. | |
Key elements of this business strategy include:
Capitalizing on Technology Expertise to Expand Our Product Offerings. We have developed expertise, intellectual property and core capabilities in digital connectivity, personal storage systems and software technologies. We continue to capitalize on our technology base, partnerships and patents to design, develop and market a broad range of products that enable consumers to use a variety of memory, storage and rotational media. We are also committed to maintaining media neutrality to enable consumers to transfer, store, create and share images and data quickly and easily among digital devices. We leverage our considerable software expertise in the areas of image, video and audio format and management, as well as CD recording formats, to continue to market software applications that simplify the tasks involved in managing, authoring and publishing digital media.
Expanding Customer and Industry Relationships.We have formed relationships with a number of leading consumer product companies and other key industry participants. We intend to explore and develop long-term alliances with a diversified base of participants in other consumer electronics segments.
Promoting Brand Awareness of Our Products.It is critical that we obtain ultimate consumer acceptance of and demand for our products independent of sales that occur in conjunction with OEMs. To this end, we continue to build upon our initial success by promoting the SmartDisk name wherever possible. We are able to benefit from the powerful advertising and promotion of our products by the OEMs while simultaneously building our brand identity. We have developed marketing programs designed to promote our product brands and enhance brand awareness such as product sampling for editorial reviews, tradeshow exhibits, point of sale collateral including counter displays, cards, data sheets and brochures, and high value consumer promotions including “Free With Purchase” incentives as mail-in rebates. We have expanded distribution channels for our products by promoting direct sales via the Internet using email database marketing programs promoting the
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Our Company’s History and Development
SmartDisk Security Corporation, or SDSC, our predecessor, was incorporated in May 1993. At the time of incorporation, SDSC was 100% beneficially owned by Addison Fischer, the chairman of our board of directors and our principal stockholder. Upon formation, SDSC entered into a manufacturing license agreement with SmartDiskette Limited, or SDL, the indirect owner of our key patents, which was also controlled by Mr. Fischer. Under this agreement, SDL granted SDSC a license to manufacture, distribute and sell diskettes or diskette connectors relating to the fields of data and computer security, validation, and access control.
From 1993 to 1995, SDSC exploited the licensed technology on its own behalf. However, in 1996 it entered into an operating agreement with Fischer International Systems Corporation, a data security company also controlled by Mr. Fischer, to provide operating services to enhance, manufacture and sell products using this technology. Under this arrangement, SDSC developed SafeBoot, a software product for computer and network security, as well as our initial Smarty and FlashPath products.
On March 5, 1997 SmartDisk Corporation was incorporated. Its initial name was “Fintos, Inc.” which was changed to “SmartDisk Corporation” in September 1997.
In January 1998, we entered into an operating agreement with SDSC and Fischer International and commenced operations. Under this operating agreement, SmartDisk and Fischer International agreed to provide operating services to SDSC and to market and develop SafeBoot, Smarty and FlashPath on behalf of SDSC.
In February 1998, Phoenix House Investments, L.L.C., an investment company controlled by Mr. Fischer, Fischer International and Toshiba entered into a joint venture agreement which detailed a plan of capital contribution, corporate governance and business strategies for SmartDisk. Although we commenced operations in January 1998, it was under this strategic arrangement that we received our first significant capital contributions and became the successor-in-interest to SDSC.
In May 1998, Mr. Fischer contributed his shares of SDSC to Phoenix House in exchange for limited liability company units. Phoenix House was, for a short time, the sole owner of SDSC. Phoenix House was later converted to a limited partnership.
Before the significant capital contributions discussed below, all outstanding shares of SmartDisk were owned by employees of, or consultants to, SmartDisk, as a result of the exercise of stock options.
The joint venture arrangement became effective in May 1998, with the following results:
• | Toshiba purchased 2,487,500 shares of our common stock, representing approximately 23.3% of SmartDisk’s common stock immediately after the purchase, in exchange for approximately $10.0 million, consisting of a cash payment of approximately $5.0 million and the cancellation of a $5.0 million note which evidenced a prior loan made by Toshiba to SmartDisk. | |
• | Phoenix House purchased 7,350,000 shares of SmartDisk common stock, representing approximately 68.8% of our common stock immediately after the purchase, in exchange for all of the outstanding shares of SDSC. | |
• | Fischer International purchased 150,000 shares of SmartDisk common stock, representing approximately 1.4% of our common stock immediately after the purchase, in exchange for trademarks it owned relating to SafeBoot, FlashPath and Smarty. | |
• | SDSC became a wholly owned subsidiary of SmartDisk. | |
• | Fischer International, Toshiba, and Phoenix House became SmartDisk’s major stockholders. | |
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In June 1998, SDSC was merged into SmartDisk and the separate corporate existence of SDSC ended.
In May 1999, Phoenix House and the other shareholders of SDL exchanged all of their SDL shares for 515,500 shares of SmartDisk common stock. As a result of the exchange, SDL became a wholly owned subsidiary of SmartDisk.
On March 6, 2000, we completed the acquisition of VST Technologies, Inc., a Delaware corporation, located in Acton, Massachusetts, for approximately $16.4 million in cash, 1,073,490 shares of our common stock and options to acquire 443,248 shares of our common stock. Based in Boston, VST designed, developed, manufactured, and marketed FireWire and USB-based flash memory readers and personal storage solutions for PC and Macintosh-based platforms.
On April 28, 2000, we completed the acquisition of Impleo Limited, a corporation established under the laws of the United Kingdom, located in Wokingham, England, for approximately $200,000 in cash and 125,051 shares of our common stock. Impleo, a digital data transfer and storage company, sold products under the Datawise brand including digital connectivity, personal storage, and biometrics security products.
Products
Our products are designed to easily transfer digital data among digital appliances, personal computers, and the Internet, to store, organize and manage that digital data, and to create media presentations for display on a personal computer or DVD player.
Personal Storage Systems |
Hard drives.We offer USB 2.0 and FireWire portable external hard drives that operate seamlessly with both Windows and Macintosh operating systems. Both USB and FireWire are standard interfaces for connected peripheral devices to computers. Both standards encompass the communications protocols used between the connected devices and computers, as well as the electrical and physical characteristics of these connections. Most do not require power adapters and all can be connected to or disconnected from a computer without shutting down or restarting the computer. Our newest line of drives, FireLite, a 2.5-inch based portable hard disk drive storage device, has set a new standard for design, size and performance in portable hard drives. The FireLite is palm-sized and weigh less than 6 ounces. This allows users to easily transport the drives in a shirt pocket from the “home office” to the “work office” with all operating systems applications and document files intact.
We also offer a card bus product for FireWire users so they can plug our FireWire hard drives into notebooks that do not yet have FireWire ports.
Optical drives.We have implemented design, portability and ease of use features into our FireWire portable CD-read/write drives so they are simple to use, durable and fast. Like our hard drives, they do not require their own power supply and can be connected to and disconnected from the personal computer without requiring the user to shutdown or restart the computer. This is an important benefit for mobile users. The drives support both Windows and Macintosh operating systems.
Floppy drive products.Our portable external USB floppy disk drives also operate seamlessly with both Windows and Macintosh computers. They address the need of Macintosh users for a floppy capability because Apple no longer includes floppy disk drives in its units. In addition, Windows notebook users represent another growing market for these products.
Personal storage products accounted for approximately 0%, 52%, and 62% of our total revenue in 1999, 2000, and 2001, respectively. Personal storage products accounted for approximately 68% of our total revenue during the nine-month period ended September 30, 2002.
Digital Connectivity Products |
FlashPath.FlashPath is a solid-state electronic device in the shape of a 3.5-inch floppy diskette that serves as a holder for a flash memory card, the film from a digital camera, to transfer images from digital
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USB-Based Flash Media Readers.Our USB flash media readers allow convenient transfer of content between a personal computer and all leading flash media cards, including CompactFlash, SmartMedia, MultiMedia Card, Secure Digital and Memory Stick. Attachment of the readers to the PC involves no driver installation in most cases, thanks to our adherence to industry standards for USB “mass storage” devices. A consumer can use these products to quickly transfer data from (and to) an appliance such as a digital camera, digital video camera, cell phone, voice recorder or music player by inserting the appliance’s flash media card in the USB reader and performing normal personal computer copying tasks.
Digital connectivity products accounted for approximately 92%, 46% and 36% of our total revenue in 1999, 2000 and 2001, respectively. Digital connectivity products accounted for approximately 32% of our total revenue during the nine-month period ended September 30, 2002.
Software.Our CD creation software, SmartDisk MVP, allows consumers to create multimedia presentations that combine their digital pictures, video and music — all with a few clicks of a mouse. The creations can be played back using a personal computer or with a DVD player and a television. Featuring a familiar entertainment center interface, SmartDisk MVP facilitates ease of use in managing and organizing digital content. The software also allows users to print digital photographs singly or as an album, in various sizes. Digital picture album covers may be customized with any digital image or video frame from a collection.
Research & Development
Technology |
Since our inception, we have focused our research and development efforts on developing and acquiring products that consumers can use to acquire, store, manage, and view their digital content. We believe these efforts have led us to develop expertise in a number of related technology areas, including flash memory technologies, particularly in interfacing with various formats of flash memory; hard disk interfacing technologies; optical drive interfacing technologies; USB 1.1 and USB 2.0; FireWire (1394A); Windows and Macintosh low and mid-level drivers; image, video, and audio digital formats and transformations; optical image formats (e.g., various CD and DVD logical formats); multimedia authoring; and Windows application programming techniques (particularly involving media management). We have also developed a team and process we believe is adept at matching new technologies with consumer needs and bringing the resultant products to market.
Digital Connectivity.We have used our knowledge of flash memory, USB, and operating system drivers to provide products that allow consumers to transfer digital content between flash media and Windows and Macintosh computers.
Personal Storage Systems.Our storage products are compatible with a broad range of computer hardware and software. These include both Windows and Macintosh operating systems and USB and FireWire system technologies. Some of these products are bundled with software applications that include capabilities such as encryption, password protection, boot capability, and drive partitioning.
Software.The SmartDisk MVP software package incorporates proprietary technology developed internally and through acquisition, as well as licensed technology from a number of software vendors. Key technologies include management, rendering and transcoding of numerous digital image, video and audio formats; authoring of content in formats compatible with industry standard publication formats such as VCD and DVD Video; and production of optical disk output on CDR, CD read/write and a variety of DVD read/ writeable media.
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Research & Development |
Our product design and development activities are conducted in our offices in Naples, Florida and Tokyo, Japan. Our research and development teams regularly collaborate and share data and research in order to maximize innovation and development.
Naples.Our Naples team is primarily responsible for core research and development activities, including product conceptualization, software and firmware development, technical writing, electrical engineering and mechanical engineering. Our Naples team has significant expertise with hard drive, optical drive and floppy disk drive interfaces, flash memory media interfaces, driver, user and utility software interfaces and firmware design. We also employ a team of software engineers with deep knowledge of multimedia applications, including image, video and audio data, authoring for optical publication and Windows user interfaces. Our engineers and other research and development employees develop design specifications based on customer requirements and supervise our quality assurance activities. This team consists of executive management, line management, engineers, developers and quality assurance personnel.
Tokyo.Our Tokyo team actively assists in the implementation of our product designs, with primary responsibility for applied engineering, production engineering and the supervision of our contract manufacturers. Other activities include quality assurance and the localization/ translation of our products for the Japanese market.
In 1999, 2000 and 2001, our research and development expenses were approximately $5.9 million, $9.2 million and $7.7 million, respectively. Our research and development expenses were approximately $1.8 million during the nine months ended September 30, 2002.
Intellectual Property |
We do not intend to license our proprietary digital connectivity technology to flash memory card manufacturers, consumer product OEMs or other third parties in the future. We have granted certain USB and FireWire product manufacturers who are competitors a limited, non-exclusive license to include our USB and FireWire drivers in specific products for certain periods. In all cases, these versions of the USB and FireWire drivers are base level drivers, without the benefit of our complete feature set, which protects the added value of our products. Although we own 11 U.S. patents and approximately 60 foreign patents covering various aspects of our technology, we do not believe that any of this intellectual property is critical to our future success.
Our FlashPath trademark is registered in the United States and a variety of other countries in which we do business, and we will continue to evaluate the registration of additional trademarks as appropriate.
Sales and Marketing
Sales.We market and sell our products worldwide to original equipment manufacturers, or OEMs, distributors, value-added resellers, retailers and catalog houses. SmartDisk-branded products are sold through the SmartDisk Web store as well as through the following worldwide channels:
Distributors: D & H, Ingram Micro, Tech Data, Computer 2000, Navarre, North Amber and Wynit.
Retailers: Best Buy, Circuit City, CompUSA, Amazon.com, B & H, Buy.com, Dixon’s, Eckerd, FNAC, Fry’s, Good Guys, J & R, LAOX, Meijer, Micro Center, Ritz Camera and Staples.
Our direct sales staff solicits prospective customers, provides technical advice and support with respect to our products and works closely with distributors, retailers and OEMs.
Sales to foreign markets and to significant customers are set forth in the notes to our consolidated financial statements.
Marketing.Our marketing group is responsible for positioning and promoting our brands and products. Our overall marketing objective is to generate brand awareness and demand for our products and applications among our current and potential customers. Our marketing programs consist of sales promotions, public
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Operations
During the fourth quarter of 2001, we completed the assimilation of our Acton, Massachusetts operations into the Naples facility. As part of this transfer, virtually all product manufacturing was transferred to Asia. We now outsource our manufacturing to independent, contracted companies in the Philippines, Japan, and Taiwan. Under our manufacturing arrangements, we receive fully assembled and tested products based upon our proprietary designs and specifications. We select our manufacturers based upon their reputations for quality, their cost structures, their production capacities and their support of state-of-the-art manufacturing processes and systems. This strategy allows us to focus on our core research, product design and development capabilities, and to reduce the substantial capital investment required to manufacture our products. We believe that our use of experienced, high-volume manufacturers provides greater manufacturing specialization and expertise, higher levels of flexibility and responsiveness, and faster delivery of product than in-house manufacturing. In addition, we frequently seek the advice of our experienced manufacturers with respect to design changes that reduce manufacturing costs or lead times or increase the manufacturing yields and the quality of our finished products. We order products from these manufacturers on a purchase order basis and our arrangements do not provide exclusivity to either party.
To ensure that our products manufactured by others meet our standards, our production engineers generally work with our contract manufacturers throughout the production process. We establish product specifications, select the components to be used to produce our products, select the suppliers, and negotiate the prices for key components. We also work with our contract manufacturers to improve process control and product design, and conduct periodic, on-site inspections of our manufacturers. In addition, our production engineers conduct regular review meetings with our manufacturers to discuss sales forecasts and the procurement of long lead-time parts, production capacities and facilities.
Other SmartDisk operations functions are procurement, technical support and order administration.
Customers and Partners
We have developed, maintained and continue to explore relationships with industry participants that can assist us in the development of new products, provide us with access to leading edge manufacturing capabilities and market and distribute our products globally. These relationships include:
Apple.We have worked with Apple as an Apple developer. This relationship has allowed us to focus on new opportunities in the development and engineering of many FireWire and USB systems. We sell products to Apple that, in turn, distributes them to their customers. Most of these sales are made through the Apple Web store.
Sony.Under our co-development agreements with Sony, we have developed FlashPath products for use with the Sony Memory Stick. We are manufacturing, and Sony is marketing and distributing, these co-developed products.
Ingram Micro.We use Ingram Micro Inc. as our primary distributor of products in the United States. We also use the IM-Logistics division of Ingram Micro Inc., the largest global wholesale provider of technology and supply chain management, as our fulfillment and logistics provider. IM-Logistics manages our warehousing, inventory, order management and transportation processes to help optimize our operations.
Toshiba.Toshiba Corporation, a leading electronics company, played a critical role in our early development stage. Toshiba made an equity investment and introduced us to most of the key technical personnel that now constitute our Tokyo-based general management, applied engineering and production engineering team. Currently, Toshiba provides us with product on an arm’s length price basis.
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Competition
The market for digital connectivity, storage products, multimedia management and CD creation software is intensely competitive and characterized by rapidly changing technology and consumer preferences. We believe that competition is likely to intensify as a result of increasing demand for digital appliances.
In the digital accessories and hardware peripherals markets we face competition from numerous providers of cable and other non-cable interfaces, including ports, USB and infrared interfaces, and stand-alone FireWire and USB personal storage devices. There are no competitors known to us that offer a digital connectivity product for flash memory in the 3.5-inch floppy format.
We believe that important competitive factors in our markets are quality, performance, price, time-to-market introduction, ease of use, reliability and technical service and support. We believe that we compete favorably with respect to these factors.
In order for us to compete successfully against current and future competitors, we continue to shorten our time-to-market introduction, incorporate new design and technology features, reduce manufacturing costs, and differentiate our products through effective marketing and advertising.
Employees
As of December 31, 2002, we had 40 full-time employees working in the United States, Europe and Japan, including 5 employees engaged in research and development, 16 engaged in sales, marketing and customer support, and 19 engaged in general, administrative, and operational activities, which includes certain executive officers, finance, operations and information systems personnel. Our employees are not represented by any collective bargaining agreements, and we have never experienced a work stoppage. We believe our employee relations are good.
Backlog
Our backlog at November 30, 2002 was approximately $1.6 million compared to approximately $5.7 million at December 31, 2001. The decrease in backlog of approximately $4.1 million resulted primarily from the decrease in sales to our OEM customers. A substantial portion of our backlog is typically scheduled for delivery within 30-60 days. Variations in the size and delivery schedules of purchase orders received by us, as well as changes in customers’ delivery requirements, may result in substantial fluctuations in backlog from period to period. Accordingly, we believe that backlog cannot be considered a meaningful indicator of future financial results.
Properties
During January 2002, we announced our plans to relocate our corporate headquarters to a new 27,000 square foot office building and distribution center in Westlinks Business Park, Fort Myers, Florida. We plan to occupy the building during March 2003. The purpose for the relocation is to consolidate our U.S.-based distribution functions into southwest Florida from a facility in Tennessee and to reduce costs as part of our multi-year effort to reduce our cost structure and improve our financial performance. We believe that this new facility will be adequate to support our operations for the foreseeable future
Currently, our corporate headquarters are located in Naples, Florida where we lease approximately 15,000 square feet of space. Our Japanese subsidiary leases approximately 4,200 square feet of office space in Tokyo, which serves as the headquarters for our Asian manufacturing management and for our Asian sales team. Our subsidiary in the United Kingdom leases approximately 5,900 square feet of office space and approximately 3,300 square feet of warehouse space in Famborough, England, which serves as the sales and distribution center of our digital connectivity and personal storage products to the European market. We believe that our current facilities are adequate to support our existing operations.
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Legal Proceedings
On June 26, 2000, a complaint was filed in the Central District Federal Court of the State of California by PC Connector Solutions, LLC alleging our infringement of its patent. PC Connector Solutions contends that our floppy disk adapters, “FlashPath” and “Smarty” (which are no longer made by us) infringe its patent. We began to sell the FlashPath products during April 1998 and continue to sell those products currently. We sold Smarty products beginning in April 1998. The plaintiff’s complaint seeks an undisclosed amount of damages, an injunction, and recall as well as attorneys’ fees. PC Connector Solutions’ patent relates to a computer with a floppy diskette drive coupler that is shaped like a floppy disk and that couples to and from an external end user computer peripheral device having an input/output port “normally connectable” or “traditionally connectable” to a “conventional” or “standard” computer input/output port. We believe that PC Connector Solutions amended its patent application claims to add the quoted limiting language after it was unsuccessful in persuading the U.S. Patent and Trademark Office to approve broader claims. We do not believe that we use the claimed technology since our products do not provide the claimed coupling to an external peripheral device, nor to any peripheral device that was normally or traditionally connectable to a conventional or standard computer input/output port as of the October 1988 filing date of the plaintiff’s patent. We do not believe that the flash memory and smart card modules that our FlashPath and former Smarty products couple to a computer are end user peripheral devices that were “normally” or “traditionally” connectable to a “conventional” or “standard” computer input/output port on the back of a computer. On November 20, 2000, we prevailed in moving the venue for such action from the State of California to the Middle District of Florida. During November 2001, prior to any discovery in the litigation, the court granted a Joint Motion to Stay the litigation pending a Request for Reexamination by the U.S. Patent and Trademark Office filed by the patent owner, which has since been lifted. In a November 2002 Reexamination Certificate, the U.S. Patent and Trademark Office confirmed the patentability of all patent claims. Based on the discussion above, and for other reasons, we consider this claim to be wholly without merit. We intend to vigorously defend against this claim. See “Risk Factors — Infringement claims by third parties could result in costly litigation and otherwise adversely impact our business.”
On July 26, 2001, a securities class action suit was filed against us, several of our executive officers and directors, including Addison M. Fischer, Michael S. Battaglia and Michael R. Mattingly, and the following underwriters of our initial public offering: FleetBoston Robertson Stephens, Inc. (formerly BancBoston Robertson Stephens, Inc.), Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. The suit was filed in the United States District Court for the Southern District of New York on behalf of all persons who acquired our common stock between October 6, 1999 and December 6, 2000. The complaint charges defendants with violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 (and Rule 10b-5 promulgated thereunder), for issuing a registration statement and prospectus that contained material misrepresentations and/or omissions. The complaint alleges that the prospectus was false and misleading because it failed to disclose (i) the agreements between FleetBoston Robertson Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain investors to provide them with significant amounts of restricted shares of our common stock in the IPO in exchange for excessive and undisclosed commissions; and (ii) the agreements between FleetBoston Robertson Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain customers under which the underwriters would allocate shares in the IPO to those customers in exchange for the customers’ agreement to purchase shares of our common stock in the after-market at pre-determined prices. The complaint seeks an undisclosed amount of damages, as well as attorney fees. This lawsuit is in one of the more than 300 class actions that have been filed against various underwriters, issuers and individuals in the United States District Court for the Southern District of New York. These cases have been consolidated and we, together with all or substantially all of the underwriters, issuers and individual defendants in these consolidated class actions, have moved to dismiss all of the consolidated amended complaints, including those directed against us, as legally insufficient. All discovery in these consolidated actions has been stayed pending determination of the motions to dismiss. Pursuant to the terms of a tolling agreement, the action has been dismissed without prejudice against each of the individual defendants named in the suit. Because these claims involve alleged secret agreements between underwriters and their investors and customers that were unknown to us and because of other legal inadequacies in the plaintiff’s allegations, we believe this claim, as it relates to
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On November 30, 2001, a complaint was filed in the Southern District of New York by Dynacore Holdings Corporation and Dynacore Patent Litigation Trust alleging our infringement of said parties’ patent relating to local area network capabilities. The complaint seeks an undisclosed amount of damages, injunction and recall, as well as attorney fees. We have signed a joint defense agreement with the other defendants, and the defendants have filed a dispositive motion for summary judgment. We consider this claim, as it relates to us, to be wholly without merit and we will vigorously defend against such claim.
On May 6, 2002, we received a demand from the trustee in the bankruptcy proceeding of MicroAge, Inc., one of our former customers, for recovery of approximately $0.505 million that MicroAge, Inc. had paid to us over the period from January 15, 2000 to April 13, 2000, inclusive. We dispute the amount demanded and intend to defend against the demand.
On June 13, 2002, we received a letter from counsel to SoftRAID LLC demanding payment of $0.285 million pursuant to a Software License Agreement with us. On July 31, 2002, SoftRAID notified us of its intention to arbitrate this dispute pursuant to the arbitration provisions of the Software License Agreement, and the American Arbitration Association had commenced administration of this proceeding. The parties settled the matter during August 2002. The cost of the settlement was not material to us.
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MANAGEMENT
Executive Officers and Directors
The following table sets forth certain information regarding our executive officers and directors.
Name | Age | Position | ||||
Addison M. Fischer | 54 | Chairman of the Board of Directors | ||||
Michael S. Battaglia | 57 | President, Chief Executive Officer and Director | ||||
Peter J. Quinn | 46 | Chief Financial Officer | ||||
Stuart Cox | 46 | Vice President — Product Development | ||||
Yoshiaki Uchida | 59 | Senior Vice President and General Manager, Asian Operations | ||||
Anthony A. Ibargüen | 42 | Director(1)(2)(3) | ||||
Emmanuel A. Kampouris | 67 | Director(1)(3) | ||||
Kiyoshi Kobayashi | 51 | Director | ||||
Timothy Tomlinson | 52 | Director(1)(2) |
(1) | Member of the Audit Committee |
(2) | Member of the Compensation Committee |
(3) | Member of the Special Committee (as described further in “The Rights Offering — Formation and Actions of the Special Committee of our Board of Directors”). Hatim Tyabji, one of our directors who resigned effective December 31, 2002, also served as a member of the Special Committee. |
Addison M. Fischerhas served as Chairman of the Board of Directors since our inception in 1997. Mr. Fischer has been an investor in numerous emerging technology companies as his principal occupation for at least the past five years. Many of these companies are involved in the fields of computer security and office automation. He also serves on the board of directors of a number of companies, including Fischer International Systems Corporation, a privately held software company which he controls. He was also a long-time board member of and significant investor in RSA Data Security, Inc., a leader in cryptographic software, until its merger in 1996 with RSA Security Inc., which was formerly known as Security Dynamics Technologies, Inc. Mr. Fischer also controls Phoenix House Investments, LP, one of our principal stockholders. In addition, Mr. Fischer was one of the founders of VeriSign, Inc., a publicly held electronic credentials/digital certificate company. Mr. Fischer was a member of committees that set U.S. standards for computer security and electronic commerce. He has addressed the U.S. Congress, by invitation, on several topics, including digital signature standards, proposed FBI digital telephony legislation, and global U.S. competitiveness. Mr. Fischer holds numerous U.S. and international patents, and is a lifetime member of the Association of Former Intelligence Officers.
Michael S. Battagliahas served as our President and Chief Executive Officer since January 1998 and as a director since October 1998. From May 1995 to December 1998, Mr. Battaglia was President and Chief Executive Officer of Fischer International Systems Corporation, a company controlled by Addison Fischer, our Chairman of the Board of Directors and holder of a majority interest in Phoenix House Investments, LP, one of our principal stockholders. During 1998, Mr. Battaglia also served as an officer of Fischer International. From August 1992 to December 1994, Mr. Battaglia was President of Mosler Inc., a provider of electronic security systems and security equipment. For the 25-year period prior to his tenure at Mosler, Mr. Battaglia held various senior management positions in the computer and information systems industry. He spent most of his professional career at Sperry Corporation in New York City and Philadelphia. Mr. Battaglia also serves on the board of directors of Fischer International, which is privately held.
Stuart Coxhas served as our Vice President, Product Development since March 2001. From August 1999 through February 2001, he served as our Director, Systems and Technology — Audio and Video Products.
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Peter J. Quinnhas served as our Chief Financial Officer since April 2002. Prior to joining our company, Mr. Quinn served as the Executive Vice President and Chief Financial Officer of Numerex Corp., a communications technology company headquartered in Atlanta from December 1999 until April 2002. Prior to that time, Mr. Quinn served as the Chief Financial Officer for Uplink Security, Inc., a high technology company that was acquired by Numerex in May 1998. Mr. Quinn also held a number of financial management positions in Ireland before his move to the United States to join Uplink.
Yoshiaki Uchidahas served as our Senior Vice President and General Manager, Asian Operations, since February 2000, and previously served as our Vice President and General Manager, Asian Operations, since November 1998. Prior to that time, Mr. Uchida spent 33 years with Toshiba Corporation in various management positions. He served as Deputy General Manager of Toshiba’s OME manufacturing and development facility, and most recently was Senior Executive Vice President of MediaServe Corporation, a Toshiba affiliate.
Anthony A. Ibargüenhas served as a director since August 1999. Since January 2002, Mr. Ibargüen has served as a Managing Director with Safeguard Scientifics, Inc., a publicly held leader in identifying, developing and operating technology and business services companies. From December 1999 to October 2001, he served as a President of Professional Services, Managing Director and then Venture Partner with Internet Capital Group, a publicly held technology holding company. From September 1996 through December 1999, Mr. Ibargüen was President of the Americas then President and Chief Operating Officer of Tech Data Corporation, a Fortune 100 distributor of information technology products and services. From August 1993 to August 1996, Mr. Ibargüen was Executive Vice President of Sales and Marketing and Co-Founder of Entex Information Services, Inc., an information technology services company. Mr. Ibargüen is also a director of Fortress Technologies, Inc. and Kanbay International, both of which are privately held.
Emmanuel A. Kampourishas served as a director since April 2001 and is currently retired. From 1966 until he retired in December 1999, Mr. Kampouris served in various management positions at American Standard Companies Inc. and its subsidiaries, including Vice President and Group Executive of its International Division, Senior Vice President of the Building Products sector and from 1989 as President and Chief Executive Officer. He also served as Chairman of American Standard’s board of directors from 1993 until he retired at the end of 1999. He serves on the board of Stanley Works Corporation, a manufacturer of tools and home décor products, Horizon Blue Cross and Blue Shield, a provider of healthcare coverage, Alticor Inc, a global direct marketer, CLICK Commerce, a channel management software company, the National Endowment for Democracy, the Hudson Institute and the Oxford University Council for the School of Management Studies.
Kiyoshi Kobayashihas served as a director since April 2001. Mr. Kobayashi has served in various management capacities with Toshiba Corporation for more than five years.
Timothy Tomlinsonhas served as a director since our inception in 1997. He co-founded Tomlinson Zisko LLP, a law firm, in 1983, and has been a partner there since that time. Since August 2001, Mr. Tomlinson has served as a Managing Director of Tierra del Oro, LLC, a venture capital fund which is affiliated with Zenerji, LLC, an asset management company, for which Mr. Tomlinson has also served as a Managing Director since September 2001. Mr. Tomlinson also serves on the board of directors of Oak Technology, Inc., a publicly held computer technology company, as well as other privately held companies, including Fischer International where he has served since April 1999 and Portola Packaging, Inc., a plastic packaging company.
Committees of the Board of Directors
Audit Committee. The audit committee of the board of directors reviews and monitors our corporate financial reporting and our external audit, including, among other things, our internal control structure, the results and scope of the annual audit and other services provided by our independent auditors. For the fiscal year ended December 31, 2001, the audit committee was composed of Messrs. Ibarguen, Kampouris, and
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Compensation Committee. The compensation committee reviews and makes recommendations to the board regarding all forms of compensation provided to our executive officers and directors and those of our subsidiaries, including stock compensation and loans. In addition, the compensation committee reviews and makes recommendations on stock compensation arrangements for all of our employees. The compensation committee also administers our 1998 Employee Stock Option Plan, 1998 Directors and Consultants Plan, Amended and Restated 1999 Incentive Compensation Plan and 1999 Employee Stock Purchase Plan.
Executive Compensation
Summary of Cash and Other Compensation |
The following table sets forth information concerning total compensation earned or paid to our Chief Executive Officer and our four most highly compensated executive officers who served in such capacities as of December 31, 2002, collectively referred to below as the “named executive officers,” for the fiscal years ended December 31, 2000, 2001, and 2002.
Summary Compensation Table
Long Term | |||||||||||||||||
Compensation | |||||||||||||||||
Awards | |||||||||||||||||
Annual Compensation | Securities | ||||||||||||||||
Underlying | |||||||||||||||||
Name and Principal Position | Year | Salary | Bonus | Options(1) | |||||||||||||
Michael S. Battaglia | 2002 | $ | 352,083 | $ | 6,094 | 200,000 | |||||||||||
Chief Executive Officer and President | 2001 | $ | 325,000 | $ | 46,700 | 112,500 | |||||||||||
2000 | $ | 275,000 | $ | 37,750 | 325,000 | ||||||||||||
Peter J. Quinn | 2002 | $ | 193,582 | $ | 35,000 | 150,000 | |||||||||||
Chief Financial Officer(2) | |||||||||||||||||
Rod H. King | 2002 | $ | 229,167 | $ | 12,875 | 30,000 | |||||||||||
Former Senior Vice President — Sales | 2001 | $ | 217,708 | $ | 28,917 | 150,000 | |||||||||||
and Marketing(2) | |||||||||||||||||
Stuart Cox | 2002 | $ | 184,867 | $ | 2,700 | 50,000 | |||||||||||
Vice President — Product Development | 2001 | $ | 163,589 | $ | 35,450 | 19,000 | |||||||||||
2000 | $ | 171,801 | $ | — | 68,100 | ||||||||||||
Yoshiaki Uchida | 2002 | $ | 166,308 | $ | 1,797 | 75,000 | |||||||||||
Senior Vice President and General Manager, | 2001 | $ | 170,000 | $ | 26,000 | 22,500 | |||||||||||
Asian Operations | 2000 | $ | 185,000 | $ | 27,500 | 65,000 |
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(1) | The exercise price of all options granted were equal to or greater than the fair market value of our common stock on the date of grant. |
(2) | Mr. Quinn joined our company during April 2002. Mr. King joined our company during March 2001 and resigned as an officer of our company effective October 2002. |
Stock Option Grants |
The following table sets forth each grant of stock options during the fiscal year ended December 31, 2002 to each of the named executive officers. No stock appreciation rights were granted to these individuals during that year.
Option Grants In Last Fiscal Year
Individual Grants | Potential Realizable | |||||||||||||||||||||||
Value at Assumed | ||||||||||||||||||||||||
Percentage | Annual Rates | |||||||||||||||||||||||
Number of | of Total | of Stock Price | ||||||||||||||||||||||
Securities | Options | Appreciation for | ||||||||||||||||||||||
Underlying | Granted to | Option Term(1) | ||||||||||||||||||||||
Options | Employees in | Exercise | Expiration | |||||||||||||||||||||
Name | Granted(#) | Fiscal Year | Price ($/Sh) | Date | 5%($) | 10%($) | ||||||||||||||||||
Michael S. Battaglia | 200,000 | (2) | 14.0 | % | $ | 1.54 | 1/28/12 | $ | 193,700 | $ | 490,873 | |||||||||||||
Peter J. Quinn | 150,000 | (3) | 10.5 | % | $ | 1.20 | 4/22/12 | $ | 113,201 | $ | 286,874 | |||||||||||||
Rod H. King | 30,000 | (2) | 2.1 | % | $ | 1.54 | 1/28/12 | $ | 29,055 | $ | 73,631 | |||||||||||||
Stuart Cox | 50,000 | (2) | 3.5 | % | $ | 1.54 | 1/28/12 | $ | 48,425 | $ | 122,718 | |||||||||||||
Yoshiaki Uchida | 75,000 | (2) | 5.2 | % | $ | 1.54 | 1/28/12 | $ | 72,637 | $ | 184,077 |
(1) | Potential gains are net of the exercise price, but before taxes associated with the exercise. Potential realizable value is based on the assumption that the common stock price appreciates at the annual rate shown, compounded annually, from the date of grant until the end of the option term. The amounts have been calculated based on the requirements promulgated by the Securities and Exchange Commission. The actual value, if any, a named executive officer may realize will depend on the excess of the stock price over the exercise price on the date the option is exercised, if the executive were to sell the shares on the date of exercise. Therefore, there is no assurance that the value realized will be equal to or near the potential realizable value as calculated in this table. |
(2) | Each of the options granted has a term of ten years from the date of grant, and 6.25% of each option grant vests on each quarterly anniversary of the date of grant. The vesting of the options is subject to acceleration upon a change of control of our company. |
(3) | The options have a term of ten years from the date of grant. One-fourth of the options vest on the anniversary of the date of grant and thereafter 6.25% of the options vest on the quarterly anniversary of the date of grant, subject to acceleration upon a change of control of our company. |
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Stock Options Held at Fiscal Year-End |
The table below sets forth certain information with respect to options held by the officers listed as of December 31, 2002. None of the officers listed exercised any options during fiscal 2002.
Options Held as of December 31, 2002
Number of Securities | ||||||||
Underlying Unexercised | ||||||||
Options at | ||||||||
December 31, 2002(1) | ||||||||
Name | Exercisable | Unexercisable | ||||||
Michael S. Battaglia | 350,009 | 362,491 | ||||||
Peter J. Quinn | — | 150,000 | ||||||
Rod H. King | 61,875 | 118,125 | ||||||
Stuart Cox | 64,986 | 88,114 | ||||||
Yoshiaki Uchida | 107,878 | 104,672 |
(1) | None of the options listed had any value at fiscal year-end, because the exercise prices of all of the options held by the listed officers were greater than $0.36, which was the closing price of our common stock as quoted on the NASDAQ SmallCap Market on December 31, 2002. |
Director Compensation
Non-employee directors receive an annual cash retainer of $12,000, plus an additional $1,500 for each meeting attended and an additional quarterly cash retainer of $1,000 for service on a board committee during each year.
Our Amended and Restated 1999 Incentive Compensation Plan includes an automatic grant program for non-employee directors. Under the plan, non-employee directors are automatically granted options to purchase 20,000 shares of common stock upon their initial election to our board of directors and 2,000 shares upon appointment to any committee and upon appointment as chairman of a committee. Thereafter, the directors are granted options to purchase an additional 10,000 shares in January of each year that they serve on the board and 4,000 shares each year that they serve as a committee member, and 2,000 shares each year that they serve as a chairman of a committee. For fiscal 2002, Mr. Tyabji, a former director of our company, and Messrs. Ibargüen, Kampouris, and Tomlinson received grants under the plan. Each option granted under the automatic grant program vests 2% a month for each month after the grant and permits the holder to purchase shares of common stock at their fair market value on the date of the grant.
During December 2002, our Board of Directors approved additional cash compensation of $5,000 to each of the three members of the Special Committee for service on the committee during fiscal 2002.
Employment Agreements
Michael S. Battaglia. Mr. Battaglia’s at will employment agreement was entered into on April 30, 2002. His annual base salary is $375,000 and he is eligible for annual merit increases at the discretion of our board of directors and an annual bonus of $187,500 for 2002 if we achieve specific revenue and profitability goals. Bonuses for the remaining years in the term are at the discretion of the compensation committee of our board of directors. If we terminate Mr. Battaglia’s employment without cause, we must pay him severance of one years’ base salary plus a pro rata portion of his target bonus for the year in which his employment was terminated. Mr. Battaglia has agreed not to compete with us for one year after his employment if he resigns or if we terminate his employment.
Rod H. King. Mr. King’s employment agreement had a three-year term ending March 16, 2004. During October 2002, Mr. King resigned as an officer of our company. Pursuant to the terms of his employment agreement, we agreed to pay Mr. King a severance of six months’ base salary. His annual base salary was
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Peter J. Quinn. Mr. Quinn’s employment agreement was entered into on April 22, 2002. His annual base salary is $210,000 and he is eligible to receive annual merit increases of at least three percent of his then current base salary at the discretion of our chief executive officer or our board of directors. Mr. Quinn is eligible to receive an annual bonus of up to $100,000, or such greater amount determined by our chief executive officer or our board of directors, pursuant to a performance bonus formula established by our chief executive officer or our board of directors. Upon his joining our company, we paid to Mr. Quinn a signing bonus of $25,000, issued to him 15,625 shares of common stock, and granted to him options to purchase 150,000 shares of our common stock at an exercise price of $1.20 per share. The options will vest 25% on the first anniversary of the date of grant and 6.25% during each subsequent quarter that the options are outstanding. If we terminate Mr. Quinn’s employment without cause, we must pay him severance of three months’ base salary and a pro rata portion of the bonus he would otherwise have received during that fiscal year. Mr. Quinn has agreed not to compete with us for one year following the termination of his employment.
Employee Benefit Plans
Amended and Restated 1999 Incentive Compensation Plan. Our board of directors adopted our 1999 Incentive Compensation Plan in July 1999 and our stockholders approved the adoption of the plan in July 1999. Our board of directors adopted our Amended and Restated 1999 Incentive Compensation Plan in March 2000 and our stockholders approved the adoption of the plan in May 2000. We have reserved 4,557,459 shares of common stock for issuance under the plan as of December 31, 2002, of which options to purchase 2,411,272 shares were outstanding as of that date. There remain 2,468,138 shares of common stock available for issuance under the plan. In addition, the number of shares of common stock reserved and available for delivery under the plan automatically increase on the first day of each calendar year by an amount equal to three percent of the total number of shares of our common stock outstanding on the last trading day of the immediately preceding calendar year. Accordingly, on January 2, 2003, the number of shares of common stock reserved and available for delivery under the plan automatically increased by 533,517 shares and such increase is included in the numbers reported above. Under the plan, officers, employees, members of the board of directors and consultants are eligible to receive awards. The types of awards that may be made under the plan are options to purchase shares of common stock, stock appreciation rights, restricted shares, deferred shares, bonus shares, dividend equivalents and other stock-based awards. Options may be either incentive stock options that qualify for favorable tax treatment for the optionee under Section 422 of the Internal Revenue Code of 1986 or nonstatutory stock options not designed to qualify for favorable tax treatment. If shares awarded under the plan are forfeited, then those shares will again become available for new awards under the plan. Annual cash awards are limited to $10.0 million per person, and annual cash performance awards are limited to $20.0 million per person.
The compensation committee of our board of directors administers the plan. The committee has complete discretion to make all decisions relating to the interpretation and operation of the plan, including the discretion to determine which eligible individuals are to receive any award, and to determine the type, number, vesting requirements and other features and conditions of each award.
The exercise price for incentive stock options granted under the plan may not be less than 100% of the fair market value of the common stock on the option grant date. The exercise price may be paid in cash or by other means, including a cashless exercise method as determined by the compensation committee.
The plan includes an automatic grant program for our non-employee directors. Under the plan, non-employee directors are automatically granted options to purchase 20,000 shares of common stock upon their initial election to the board of directors and 2,000 shares upon appointment to any committee of the board and upon appointment as chairman of a committee. Directors are granted options to purchase an additional 10,000 shares in January of each year that they serve on the board and 4,000 each year that they serve as a committee member, and 2,000 each year that they serve as chairman of a committee. All options granted under the automatic grant program vest 2% per month for each month after the grant date.
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Our board of directors may amend or terminate our plan at any time. If the board amends the plan, stockholder approval of the amendment will be sought only if required by an applicable law. The plan will continue in effect indefinitely unless the board decides to terminate the plan earlier.
1999 Employee Stock Purchase Plan. Our board of directors adopted our 1999 Employee Stock Purchase Plan in July 1999, and our stockholders approved the adoption of the plan in July 1999. We have reserved 465,000 shares of common stock for issuance under the plan, of which 120,430 shares have been issued as of December 31, 2002. There remain 344,570 shares of common stock available for issuance under the plan. Once an employee enters the plan, on the first day of each offering period he or she is granted an option to purchase shares of our common stock, up to a maximum of 1,000 shares, on June 30 and December 31 of each offering period. The plan, which is intended to qualify under Section 423 of the Internal Revenue Code of 1986, is implemented through successive twelve-month offering periods, commencing the first trading day of January each year and running until the end of the year. The plan is administered by the compensation committee. Employees become eligible to participate when they have been employed for more than five months in a calendar year, working at least 20 hours per week. The plan permits eligible employees to purchase common stock through payroll deductions, which may not exceed 15% of an employee’s compensation. The price of stock purchased under the plan will be 85% of the lower of the fair market value of the common stock at either the beginning of the offering period or the day that the employee became eligible under the plan (if after the beginning of such period), whichever is higher, or the end of each six-month exercise period. Employees may not be granted shares under the plan if immediately following a grant they would hold stock and/or options to acquire stock possessing more than 5% of the total voting power of the shares of our company. In addition, employees may be granted options to purchase a maximum of $21,250 worth of stock per year under the plan. Employees may end their participation at any time and participation ends automatically upon termination of employment with us. Our board of directors may amend or terminate the plan at any time. If the board amends the plan, stockholder approval of the amendment will be sought only if required by an applicable law.
1998 Employee Stock Option Plan. Our board of directors adopted a 1998 Employee Stock Option Plan in January 1998, and our stockholders approved the adoption of the plan in March 1998. Although we terminated this plan in July 1999, options to purchase 247,608 shares were outstanding as of December 31, 2002. We have reserved 1,454,545 shares of common stock for issuance upon the exercise of options granted under the plan.
The plan required that the exercise price for incentive stock options granted under the plan may not be less than 100% of the fair market value of the common stock on the option grant date. The exercise price may be paid in cash or, at the discretion of the compensation committee, in outstanding shares of common stock, by delivery of a promissory note, or by any combination of cash, shares of common stock or promissory notes. At the discretion of the compensation committee, the exercise price may also be paid by using a cashless exercise method.
If a merger or other reorganization occurs, and our stockholders before the transaction hold a majority of the voting securities of the acquiring or surviving corporation after the transaction, outstanding options under the plan shall become exercisable for securities of the acquiring or surviving corporation. If our stockholders before the transaction hold less than a majority of the voting securities of the acquiring or surviving corporation after the transaction, outstanding options shall generally be canceled unless the merger or reorganization agreement provides otherwise.
1998 Directors and Consultants Stock Option Plan. Our board of directors adopted a 1998 Directors and Consultants Stock Option Plan in January 1998, and our stockholders approved the adoption of the plan in March 1998. Although we terminated this plan in July 1999, options to purchase 139,593 shares were outstanding as of December 31, 2001. We have reserved 250,000 shares of common stock for issuance upon the exercised of options granted under the plan.
The plan required that the exercise price for stock options granted under the plan be determined by the compensation committee at the time of grant. The exercise price may be paid in cash or, at the discretion of the committee, in outstanding shares of common stock, by delivery of a promissory note, or by any
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If a merger or other reorganization occurs, and our stockholders before the transaction hold a majority of the voting securities of the acquiring or surviving corporation after the transaction, outstanding options under the plan shall become exercisable for securities of the acquiring or surviving corporation. If our stockholders before the transaction hold less than a majority of the voting securities of the acquiring or surviving corporation after the transaction, outstanding options generally will be canceled unless the merger or reorganization agreement provides otherwise.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Fischer International Transactions
In January 1998, SmartDisk Security Corporation, or SDSC, our predecessor, entered into an operating agreement with Fischer International to provide operating services to SDSC, including developing and marketing the SafeBoot, FlashPath and Smarty products. SDSC agreed in return to reimburse Fischer International and us for the expenses related to providing those services. Upon our obtaining control of SDSC in May 1998, this agreement was terminated and replaced with a new operating agreement between Fischer International and us. Under this new agreement, as amended in June 1999, we reimburse Fischer International for marketing, accounting and other similar services. In addition, we previously shared office space with Fischer International. We have reimbursed Fischer International for the cost of this office space as well as other general and administrative expenses. Our share of these expenses is based on an internal analysis of the relative amount of time devoted to its business by employees of Fischer International as well as the overhead charges attributable to these employees. In 1999, 2000 and 2001, we paid Fischer International approximately $1.5 million, $300,000 and $200,000 under this arrangement for the reimbursement of expenses under the operating agreement and for the other shared services.
In May 1998, we entered into license and distribution agreements with Fischer International. Under these agreements, we granted Fischer International a non-exclusive license to our SafeBoot product and distribution rights to our SafeBoot, Smarty and FlashPath products until 2001. Pursuant to this agreement, Fischer International agreed to pay us 33.3% of the net revenue derived from the sale of our products on a stand-alone basis and 5% of the net revenue derived from the sale of our products which are bundled with the products of third parties. In 1999 and 2000, we received approximately $470,000 and $71,000 from Fischer International under these agreements in royalties related to SafeBoot, and no royalties related to Smarty and FlashPath. This agreement was terminated in July 2000.
During 2000, we engaged Fischer International to assist us in licensing our SafeBoot product to a third party. We paid Fischer International approximately $290,000 for its services in connection with this transaction.
Employee Advances
On March 3, 1998, we loaned Michael Battaglia $305,114 in connection with Mr. Battaglia’s exercise of an option to purchase 426,136 shares of our common stock. The loan was amended on April 3, 2002 to modify the rate of interest to 2.88% from 5.47%, to extend the principal balance due date an additional two years to March 3, 2005, to make interest payable annually instead of quarterly and to allow Mr. Battaglia to defer, at his discretion, the payment of interest until the due date of principal. The Compensation Committee of our Board of Directors believed that modification of the loan would enable Mr. Battaglia to remain focused on increasing stockholder value. The principal balance is due on the earlier of March 3, 2005 or the end of his employment with us or an affiliate of ours. The outstanding principal balance of the loan as of June 30, 2002 was $276,937.
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Other Transactions
On January 31, 2000, we loaned Mr. Tomlinson $209,994 pursuant to a promissory note in connection with his exercise of an option to purchase 6,000 shares of our common stock for $35 per share. In November 2000, we repurchased these shares for $30,375 and cancelled the remaining balance of the promissory note.
Mr. Tomlinson is a partner of Tomlinson Zisko LLP, which provided legal services to us in 2000, 2001, and 2002. Fees paid in 2000, 2001, and 2002 to Mr. Tomlinson’s firm did not exceed 5% of the law firm’s gross revenue for the firm’s respective fiscal year.
Private Placement with Mr. Fischer and Phoenix House
On December 24, 2002, Addison Fischer, Chairman of our Board of Directors, and Phoenix House Investments, LP, an entity controlled by Mr. Fischer, purchased from us an aggregate of 2,552,364.8 shares of our Series A Redeemable Convertible Preferred Stock for gross proceeds of approximately $2.5 million. Each share of Series A Preferred is convertible into shares of common stock at an initial conversion price of $0.32 per share of common stock such that each share of Series A Preferred is initially convertible into 3.125 shares of common stock. However, in no event may the aggregate number of shares of common stock issuable upon conversion of all shares of Series A Preferred exceed 3,556,777 shares unless
• | our stockholders approve the issuance of all shares of common stock issuable upon conversion of the Series A Preferred at a meeting duly called for such purpose; | |
• | we obtain permission from NASDAQ to allow such issuance without any limitation on the number of shares of common stock issuable upon conversion of the shares of Series A Preferred; or | |
• | we are no longer governed by a rule promulgated by a stock exchange, NASDAQ, or other applicable body prohibiting the issuance of common stock upon conversion of the Series A Preferred in excess of 19.9% of the number of shares of common stock outstanding without stockholder approval. | |
Immediately upon the satisfaction of any of the conditions listed above, all outstanding shares of Series A Preferred will be converted automatically into the number of shares of common stock into which the shares of Series A Preferred are then convertible as of the date of the satisfaction of such condition. We have agreed with the holders of Series A Preferred that without the consent of a majority in interest of the holders of Series A Preferred, we will not hold a special meeting of stockholders or otherwise seek stockholder approval that would result in mandatory conversion of the Series A Preferred.
The shares of Series A Preferred have the right to that number of votes that is equal to the number of shares of common stock issuable upon any permitted conversion of the Series A Preferred, and vote together with the common stock as if a single class. See “Description of Securities — Preferred Stock — Series A Redeemable Convertible Preferred Stock.”
In connection with the private placement, a special committee of our Board of Directors, consisting of three independent directors, considered several factors in determining the price at which a share of Series A Preferred may be converted into shares of commons stock. These factors included the historic and then current market price of the common stock, our business prospects, our recent and anticipated operating results, general conditions in the securities markets, our need for capital, alternatives available to us for raising capital, the amount of proceeds desired, the pricing of similar transactions, the liquidity of our common stock, the level of risk to our investors, and the need to offer shares at a price that would be attractive to the investors in the private placement relative the then-current trading price of our common stock. The special committee also obtained an opinion of FTN Financial Securities Corp relating to the fairness, from a financial point of view, of the private placement to our then-existing stockholders, excluding Mr. Fischer and Phoenix House.
As a result of the private placement during December 2002, Mr. Fischer beneficially owns approximately 46.6% of our outstanding common stock and has the right to vote 46.6% of the shares of stock eligible to vote on any matter submitted to stockholders.
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Interests in the Rights Offering
As a result of this rights offering, our directors and officers and certain of their affiliated company stockholders will have the right to purchase additional shares of common stock at the subscription price in an amount proportional to their existing interests. These officers, directors, and affiliated companies will receive the same terms as the other stockholders in this rights offering. The following table presents certain information with respect to the shares held by certain of our officers, directors, and their affiliated companies and the shares of common stock that those officers, directors, and their affiliated companies may purchase pursuant to their basic subscription rights in this rights offering.
Common | Rights to Purchase | |||||||
Officer or Director | Shares Held | in this Offering | ||||||
Addison M. Fischer | 6,380,912 | (1) | 7,976,140 | |||||
Michael Battaglia | 368,636 | 460,795 | ||||||
Anthony A. Ibargüen | 5,000 | 6,250 | ||||||
Emmanuel A. Kampouris | 10,500 | 13,125 | ||||||
Kiyoshi Kobayashi | — | — | ||||||
Peter J. Quinn | 15,625 | 19,531 | ||||||
Timothy Tomlinson | 32,767 | (2) | 40,959 | |||||
Toshiba Corporation | 2,354,900 | 2,943,625 |
(1) | Includes 5,952,144 shares held by Phoenix House Investments, LP, which is controlled by Mr. Fischer. Excludes 3,556,777 shares of common stock issuable upon conversion of shares of Series A Preferred held by Mr. Fischer and Phoenix House. Neither Mr. Fischer nor Phoenix House will receive rights to purchase common stock for shares of Series A Preferred that were not converted to common stock as of the record date. |
(2) | Includes 1,500 shares held by trusts for which Mr. Tomlinson and his wife are the sole trustees and 22,250 shares held by an investment fund as to which Mr. Tomlinson is a general partner. Mr. Tomlinson disclaims beneficial ownership of all such shares. |
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PRINCIPAL STOCKHOLDERS
The table below sets forth information regarding the beneficial ownership of our common stock as of January , 2003, by the following individuals or groups:
• | each person or entity who is known by us to beneficially own more than 5% of our outstanding stock; | |
• | each of the executive officers named in the Summary Compensation Table above; | |
• | each of our directors; and | |
• | all directors and executive officers as a group. |
Unless otherwise indicated, each of the individuals listed in the table can be reached at our company offices at 3506 Mercantile Avenue, Naples, Florida 34104. Except as otherwise indicated, and subject to community property laws where applicable, to our knowledge the persons named in the table have sole voting and investment power with respect to all shares of common stock held by them.
The number of shares beneficially owned by each individual or group is based upon information in documents filed by such person with the Securities and Exchange Commission, other publicly available information or information available to us. Percentage ownership in the following table is based on 17,790,770 shares of common stock outstanding as of January , 2003. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Shares of our common stock subject to options that are presently exercisable or exercisable within 60 days of January , 2003 are deemed to be outstanding and beneficially owned by the person holding the options for the purpose of computing the percentage of ownership of that person, but are not treated as outstanding for the purpose of computing the percentage of any other person.
Number of Shares | Percent of | |||||||
Name of Beneficial Owner | Beneficially Owned | Shares Outstanding | ||||||
Directors and Executive Officers: | ||||||||
Addison M. Fischer | 9,937,689 | (1) | 46.6 | % | ||||
Michael S. Battaglia | 758,886 | (2) | 4.2 | |||||
Peter J. Quinn | 15,625 | * | ||||||
Rod H. King | 67,875 | (3) | * | |||||
Stuart Cox | 72,046 | (4) | * | |||||
Yoshiaki Uchida | 120,101 | (5) | * | |||||
Anthony A. Ibargüen | 38,074 | (6) | * | |||||
Emmanuel A. Kampouris | 28,300 | (7) | * | |||||
Kiyoshi Kobayashi | — | — | ||||||
Timothy Tomlinson | 52,993 | (8) | * | |||||
All directors and executive officers as a group (10 persons) | 10,983,384 | (9) | 50.3 | |||||
5% Stockholders: | ||||||||
Phoenix House Investments, LP | 9,508,921 | (10) | 44.5 | |||||
Toshiba Corporation | 2,354,900 | (11) | 13.2 |
* | Less than one percent. |
(1) | Includes 5,952,144 shares held of record by Phoenix House, an entity which Mr. Fischer effectively controls, and 3,556,777 shares of common stock issuable upon conversion of shares of Series A Preferred held by Mr. Fischer and Phoenix House. Does not include 4,419,363 shares of common stock issuable upon conversion of shares of Series A Preferred held by Mr. Fischer and Phoenix House that may not be converted unless certain conditions occur. See “Description of Securities — Preferred Stock — Series A Redeemable Convertible Preferred Stock.” |
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(2) | Includes 387,250 shares subject to options either currently exercisable or exercisable by Mr. Battaglia within 60 days of January , 2003. | |
(3) | Includes 61,875 shares subject to options either currently exercisable or exercisable by Mr. King within 60 days of January , 2003. | |
(4) | Includes 66,548 shares subject to options either currently exercisable or exercisable by Mr. Cox within 60 days of January , 2003. | |
(5) | Includes 118,124 shares subject to options either currently exercisable or exercisable by Mr. Uchida within 60 days of January , 2003. | |
(6) | Includes 33,074 shares subject to options either currently exercisable or exercisable by Mr. Ibargüen within 60 days of January , 2003. | |
(7) | Includes 17,800 shares subject to options either currently exercisable or exercisable by Mr. Kampouris within 60 days of January , 2003. | |
(8) | Includes 20,226 shares subject to options either currently exercisable or exercisable by Mr. Tomlinson within 60 days of January , 2003. Also, includes 1,500 shares held by trusts for which Mr. Tomlinson and his wife are the sole trustees. Mr. Tomlinson disclaims beneficial ownership of those shares. Also includes 22,250 shares held by an investment fund as to which Mr. Tomlinson is a general partner. | |
(9) | See footnotes (1) through (8) above. | |
(10) | Includes 3,556,777 shares of common stock issuable upon conversion of shares of Series A Preferred held by Phoenix House. Does not include 3,883,403 shares of common stock issuable upon conversion of shares of Series A Preferred held by Phoenix House that may not be converted unless certain conditions occur. See “Description of Securities — Preferred Stock — Series A Redeemable Convertible Preferred Stock.” The address for Phoenix House is Phoenix House Investments, LP, 101 Convention Center Drive, Suite 850, Las Vegas, Nevada 89109. Phoenix House is controlled by Addison M. Fischer, the chairman of our board of directors. |
(11) | The address for Toshiba Corporation is 1-1 Shibaura 1-Chome, Minato-ku, Tokyo 105, Japan. |
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THE RIGHTS OFFERING
Before exercising or selling any subscription rights, you should read carefully the information set forth under “Risk Factors.”
The Subscription Rights
We are distributing, at no cost to our stockholders, non-transferable subscription rights to stockholders that owned shares of our common stock at the close of business on , 2003. We will issue to you 1.25 subscription rights for every share of common stock that you owned on , 2003. You will not receive fractional subscription rights during the rights offering, but instead we will round your number of subscription rights down to the nearest whole number. Each subscription right will entitle you to purchase one share of common stock for $0.32. The subscription price may be paid in cash or by delivery of shares of Series A Preferred, which will be valued at $1.00 per share. If you wish to exercise your subscription rights, you must do so before 5:00 p.m., Eastern Standard Time, on , 2003. We may, at our discretion, extend the rights offering for up to 60 days. After that date, the subscription rights will expire and will no longer be exercisable. We will extend the offering period if we believe that any such extension would better allow for increased stockholder participation or if we believe that any such extension is in the best interests of our company.
Basic Subscription Privilege
Each subscription right will entitle you to purchase one share of common stock at a price of $0.32 per share. The subscription price may be paid in cash or by delivery of shares of Series A Preferred, which will be valued at $1.00 per share. You will receive certificates representing the shares that you purchase pursuant to your basic subscription privilege as soon as practicable after , 2003, irrespective of whether you exercise your subscription rights immediately prior to that date or earlier.
Over-Subscription Privilege
Subject to the allocation described below, each subscription right also gives you an over-subscription privilege to purchase additional shares of common stock that are not purchased by other stockholders. You are entitled to exercise your over-subscription privilege only if you exercise your basic subscription privilege in full. If you wish to exercise your over-subscription privilege, you should indicate the number of additional shares that you would like to purchase in the space provided on your subscription certificate. When you send in your subscription certificate, you also must send the full purchase price for the number of additional shares that you have requested to purchase, whether in cash or by delivery of certificates representing shares of Series A Preferred, in addition to the payment due for shares purchased through your basic subscription privilege.
If the number of shares remaining after the exercise of all basic subscription privileges is not sufficient to satisfy all over-subscription privileges, we will allocate the available shares among stockholders that over-subscribed in proportion to the number of shares purchased by those over-subscribing stockholders through the basic subscription privilege, and will refund any amounts due, without interest. However, if your pro rata allocation exceeds the number of shares you requested, you will receive only the number of shares that you requested, and the remaining shares from your pro rata allocation will be divided among other stockholders exercising their over-subscription privileges that have subscribed for additional shares in proportion to the number of shares purchased by that group of over-subscribing stockholders through the basic subscription privilege. In certain circumstances, however, in order to comply with applicable state securities laws, we may not be able to honor all over-subscription privileges even if we have shares available.
The following examples illustrate how shares will be allocated among stockholders that exercise their over-subscription privilege, depending on whether or not there is a sufficient number of shares remaining to
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Number of | |||||||||||||
Shares Held Prior | Basic Subscription | Over-Subscription | |||||||||||
to Rights Offering | Privilege | Requests | |||||||||||
Stockholder A: | 1,000 | 1,250 | 2,000,000 | ||||||||||
Stockholder B: | 10,000 | 12,500 | 1,700,000 | ||||||||||
Stockholder C: | 100,000 | 125,000 | 350,000 | ||||||||||
Total: | 111,000 | 138,750 | 4,050,000 | ||||||||||
Example 1:
Assume that stockholders exercise their basic subscription rights for a total of 11,000,000 shares, so that a total of 11,238,463 shares remain available for over-subscription requests. Because that number exceeds the total number of over-subscription exercises, each of Stockholders A, B, and C will receive the full number of shares they subscribed for, as follows:
Number of | Total Number of | ||||||||||||||||
Shares Held Prior | Basic Subscription | Over-Subscription | Shares Held After | ||||||||||||||
to Rights Offering | Privilege | Requests | Rights Offering | ||||||||||||||
Stockholder A: | 1,000 | 1,250 | 2,000,000 | 2,002,250 | |||||||||||||
Stockholder B: | 10,000 | 12,500 | 1,700,000 | 1,722,500 | |||||||||||||
Stockholder C: | 100,000 | 125,000 | 350,000 | 575,000 | |||||||||||||
Total: | 111,000 | 138,750 | 4,050,000 | 4,299,750 | |||||||||||||
Example 2:
Assume that stockholders exercise their basic subscription rights for a total of 19,238,463 shares, so that a total of only 3,000,000 shares remain available for over-subscription requests. Because the number of over-subscription exercises exceeds the number available, the available shares will be allocated among Stockholders A, B, and C as follows:
Stockholder A: | 3,000,000 | × | 1,250/138,750 | = | 27,027 | ||||||||||||||||
Stockholder B: | 3,000,000 | × | 12,500/138,750 | = | 270,270 | ||||||||||||||||
Stockholder C: | 350,000 | ||||||||||||||||||||
Total: | 647,297 | ||||||||||||||||||||
However, because Stockholder C over-subscribed for only 350,000 shares, only 350,000 shares will be allocated to him, even though the calculation would have permitted him to take up to 2,702,703 shares (3,000,000 × 125,000/138,750). The remaining 2,352,703 shares (3,000,000 - 647,297 = 2,352,703) will be allocated between Stockholder A and B as follows:
Total basic subscription rights exercised: | Stockholder A: | 1,250 | ||||
Stockholder B: | 12,500 | |||||
Total | 13,750 | |||||
Stockholder A: | 2,352,703 | × | 1,250/13,750 | = | 213,882 | ||||||||||||||||
Stockholder B: | 2,352,703 | × | 12,500/13,750 | = | 2,138,821 | ||||||||||||||||
Total: | 2,352,703 | ||||||||||||||||||||
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The total allocation of the over-subscription privilege will be as follows:
Stockholder A: | 27,027 | + | 213,882 | = | 240,909 | ||||||||||||||||
Stockholder B: | 270,270 | + | 2,138,821 | = | 2,409,091 | ||||||||||||||||
Stockholder C: | 350,000 | + | 0 | = | 350,000 | ||||||||||||||||
Total: | 3,000,000 | ||||||||||||||||||||
Following this allocation, Stockholders A, B, and C will own shares as follows:
Number of | |||||||||||||||||
Shares Held | Basic | Over- | Total Number of | ||||||||||||||
Prior to Rights | Subscription | Subscription | Shares Held After | ||||||||||||||
Offering | Privilege | Allocation | Rights Offering | ||||||||||||||
Stockholder A | 1,000 | 1,250 | 240,909 | 243,159 | |||||||||||||
Stockholder B | 10,000 | 12,500 | 2,409,091 | 2,431,591 | |||||||||||||
Stockholder C | 100,000 | 125,000 | 350,000 | 575,000 | |||||||||||||
Total | 111,000 | 138,750 | 3,000,000 | 3,249,750 | |||||||||||||
Unsubscribed Shares
Any shares that are not subscribed for in this rights offering may be offered to potential new investors at the same price per share offered in the rights offering, immediately following the expiration of the rights offering. The offering to potential new investors will not be an underwritten offering. Our officers and directors will conduct the offering to potential new investors on our behalf. We reserve the right, in our sole discretion, not to proceed with the offering or sale of shares to the new investors. Before we offer shares of common stock to other potential new investors, we will consider the level of stockholder participation in the rights offering and the amount of net proceeds received from existing stockholders who exercise their subscription rights. In addition, any decision by us to offer shares to potential new investors will be based on our assessment of our capital structure, liquidity, the subscription price of common stock compared with our assessment of the underlying value of our company, and other factors. As of the date of this prospectus, we have not made any offers to potential new investors and have not engaged in any discussions or negotiations with potential new investors. We cannot assure you that we will seek or obtain potential new investors in this rights offering.
No Recommendation
Our company and our Board of Directors are not making any recommendations as to whether or not you should exercise your subscription rights. You should make your decision based on your own assessment of your best interests.
Expiration Date
The rights will expire at 5 p.m., Eastern Standard Time, on , 2003, unless we decide to extend this rights offering for up to 60 days. We will extend the offering period if we believe that any such extension would better allow for increased stockholder participation or if we believe that any such extension is in the best interests of our company. If you do not exercise your subscription rights prior to that time, your subscription rights will be null and void. We will not be required to issue shares of common stock to you if the subscription agent receives your subscription certificate or your payment after that time, regardless of when you sent the subscription certificate and payment, unless you send the documents in compliance with the guaranteed delivery procedures described below.
Withdrawal Right
Our Board of Directors may withdraw this rights offering in its sole discretion at any time prior to or on , 2003, for any reason, including, without limitation, a change in the market price of our common
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Formation and Actions of the Special Committee of our Board of Directors
On July 30, 2002, at a regular meeting of our Board of Directors, the Board of Directors discussed a variety of possible alternative transactions intended to address our liquidity constraints. As part of such general discussion, the Board discussed the possible benefits of a rights offering to existing stockholders and, in connection with such discussion, appointed a special committee consisting of Messrs. Tyabji, Ibargüen, and Kampouris, all independent directors of our company, to explore strategic alternatives for our company, including a possible rights offering. The Board of Directors also authorized the special committee to engage its own financial advisor and legal counsel.
On July 31, 2002, a telephonic meeting of the newly formed special committee was held. At the meeting, the special committee engaged our corporate outside counsel to represent the special committee as its legal counsel, received a summary presentation from counsel on their fiduciary duties, discussed the engagement of a financial advisor and requested that counsel seek additional information from Mr. Fischer with respect to his interest in participating in a possible rights offering and the basic parameters of such interest.
On August 7, 2002, during a telephonic meeting, the special committee and its legal advisor discussed the qualifications, preliminary views and potential interest of six nationally recognized investment banking firms that had been previously contacted in connection with their possible engagement as financial advisor to the special committee.
On August 9, 2002, Mr. Fisher provided the special committee with an informal indication of his interest in participating on a pro rata basis in an approximately $7.5 million rights offering to our stockholders. The informal proposal did not specify a subscription price.
On August 14, 2002, the special committee held another telephonic meeting, during which the special committee discussed Mr. Fischer’s proposal and the benefits and parameters of a rights offering generally. The special committee also discussed the engagement of a financial advisor and determined to engage FTN Financial Securities Corp as the financial advisor to the special committee.
On September 9, 2002, the special committee held a telephonic meeting during which the special committee and its legal and financial advisors discussed the status of the preparation of the registration statement, recommended timing and terms of the rights offering, and other issues to be resolved prior to commencing a rights offering. The committee’s financial advisor also summarized for the special committee its activities to date, its preliminary views with respect to the rights offering, and expectations regarding the analysis that would support its opinion. After discussion of these and other issues, the special committee approved resolutions recommending to the board of directors (subject to deferral of the determination of the number of rights to be issued per outstanding share and the per share subscription price) the rights offering as described in this prospectus, declaration of the rights dividend, and all other procedures and arrangements required to commence the rights offering, including the filing of the registration statement.
On September 12, 2002, the Board of Directors held a telephonic meeting during which the special committee reported to the Board of Directors its recommendations described above. The special committee and its legal advisors discussed the progress of the registration statement, the analysis of the financial advisor, and the proposed timing of the rights offering and related issues. After discussion of these matters, the Board of Directors approved resolutions authorizing (subject to deferral of the determination of the number of rights to be issued per outstanding share and the per share subscription price) the rights offering as described in this prospectus, declaration of the rights dividend, and all other procedures and arrangements required to commence the rights offering, including the filing of the registration statement.
On October 23, 2002, the special committee held a telephonic meeting during which the committee’s legal advisors reported that the registration statement in connection with the rights offering had been selected for review by the SEC. The legal advisors discussed with the special committee the general nature and extent of the SEC comments.
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On November 14, 2002, the special committee held a telephonic meeting during which the committee’s legal advisors reported recent discussions with Mr. Fischer’s counsel relating to Mr. Fischer’s desired investment parameters. The committee members expressed concerns over the uncertainty with respect to Mr. Fischer’s investment and discussed possible ways of obtaining greater certainty with respect to a potential investment. The committee also expressed concerns over the expenses of the rights offering and requested that management provide estimates of the likely costs required to be incurred to complete the proposed rights offering and any investment by Mr. Fischer. The committee’s legal advisors discussed various possible changes to the structure of an investment by Mr. Fischer, including a private placement to Mr. Fischer to be followed by a rights offering to other existing stockholders. The committee’s financial advisors discussed the procedural aspects of their opinion in light of the various structures.
On November 21, 2002, the special committee held a telephonic meeting during which the committee’s legal advisors reported that Mr. Fischer was prepared to invest $2.5 million. The committee was advised that, although counsel for the committee and counsel for Mr. Fischer discussed various possible structures of any such investment, such counsel had not discussed a per share purchase price. The special committee and representatives of the special committee’s financial advisors discussed the appropriate subscription/conversion price to be used in connection with any investment by Mr. Fischer. The special committee also expressed its belief that any investment by Mr. Fischer should be followed by a rights offering. The special committee also discussed a draft proposal letter to Mr. Fischer, prepared by the special committee’s counsel, that contemplated his purchase of a convertible promissory note.
On November 25, 2002, counsel for Mr. Fischer presented a proposal to counsel for the special committee whereby Mr. Fischer would invest $2.5 million in the form of a promissory note convertible into shares of common stock.
On November 27, 2002, the special committee held a telephonic meeting during which it reviewed the terms of Mr. Fischer’s proposal and expressed various concerns with respect to an investment in the form of a convertible promissory note rather than convertible preferred stock. The special committee discussed the structure of the investment as well as the difficulty in pricing any transaction at that time as a result of recent increases in the price of our common stock. The special committee concluded the meeting by requesting that the special committee’s counsel discuss such concerns with counsel for Mr. Fischer.
Between November 27, 2002 and December 4, 2002, counsel for the special committee and Mr. Fischer discussed the proposal for Mr. Fischer to purchase convertible preferred stock from the company. The parties negotiated the terms of such proposed purchase of preferred stock.
On December 5, 2002, the special committee held a telephonic meeting during which it reviewed the terms of the revised proposal for a purchase by Mr. Fischer of preferred stock. The special committee and its financial advisor discussed various alternatives and approaches for determining the conversion price of the convertible preferred stock. The special committee also noted that the then increasing price of our common stock could possibly impact our ability to complete the proposed private placement and ultimately any rights offering. The special committee authorized its legal counsel to proceed with the negotiation and our execution of a preferred stock purchase agreement, subject to the receipt of a fairness opinion from the special committee’s financial advisor.
Between December 5, 2002 and December 9, 2002, legal advisors for the special committee and Mr. Fischer negotiated the preferred stock purchase agreement between the parties and the terms of the Series A Redeemable Convertible Preferred Stock, including pricing and conversion terms. On December 9, 2002, Mr. Battaglia and Mr. Fischer executed the agreement. Between December 9, 2002 and December 15, 2002, legal advisors for the special committee and Mr. Fischer negotiated the documents contemplated by such agreement, including the certificate of designations for the Series A Preferred, a registration rights agreement, the form of opinion from the company’s counsel in connection with the investment, and other ancillary documents.
On December 16, 2002, the special committee held a telephonic meeting during which it reviewed and discussed the documents associated with the purchase of preferred stock by Mr. Fischer and Phoenix House.
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• | the stock purchase agreement and related documents outlining the transaction; | |
• | certain publicly available information that the financial advisors believed to be relevant to its analysis, including our annual report for the year ended December 31, 2001 and our quarterly reports for the quarters ended March 31, 2002, June 30, 2002, and September 30, 2002; | |
• | certain other financial information, reports, and other internal information that was provided to the financial advisors by us; | |
• | the strategic and financial objectives for the transaction; | |
• | a comparison of the premium or discount of the conversion feature associated with the transaction with the premium or discount to the market price of the relative private placements of convertible notes or preferred stock that the financial advisors deemed comparable; | |
• | our then-current liquidity position and the impact on our operations, including our customers and employees, of a lack or perceived lack of liquidity; | |
• | a review of the dilutive impact of the above transactions, noting those transactions involved company insiders; | |
• | alternative sources of capital that may be available to us and the terms likely associated with such alternatives; and | |
• | our current and projected financial obligations, including our working capital needs and our ability to fund such obligations based on then-current and projected operations. | |
The financial advisors reported that based upon the foregoing and subject to various assumptions disclosed to the special committee, that in their opinion, the transaction was fair, from a financial point of view, to our stockholders, excluding Mr. Fischer and Phoenix House. After discussion of the opinion and review of the transaction documents, the special committee approved the transaction and recommended that our Board of Directors approve of such transactions.
Immediately following the December 16, 2002 special committee meeting, our full Board of Directors held a telephonic meeting during which the special committee reported to the Board of Directors its recommendations described above. The special committee and its legal advisors discussed the progress of the transaction, the analyses and fairness opinion of the financial advisor, and the proposed timing for consummation of the private placement with Mr. Fischer and Phoenix House. After discussion of these matters, the Board of Directors approved the preferred stock purchase agreement and the private placement to Mr. Fischer and Phoenix House, the registration rights agreement, calling a special meeting of our stockholders on such date as approved by our President to approve the issuance of all of the shares of common stock issuable upon conversion of the Series A Preferred and, pursuant to the recommendation of the special committee and the requirements of the preferred stock purchase agreement, this rights offering.
On December 18, 2002, the legal advisors for Mr. Fischer and the special committee discussed a proposed amendment to the preferred stock purchase agreement to evidence our agreement not to call a special meeting of stockholders until requested by Mr. Fischer and Phoenix House and to permit Mr. Fischer and Phoenix House to purchase shares of common stock in the rights offering by tendering shares of Series A Preferred. Between December 18, 2002 and December 23, 2002, the parties discussed the various terms and negotiated the first amendment to the preferred stock purchase agreement. On December 24, 2002, the parties executed the amendment to the preferred stock purchase agreement and consummated the sale of the preferred stock.
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Determination of the Subscription Price
The offering price per share in this rights offering is equal to the conversion price per share of the Series A Preferred offered and sold in the private placement to Mr. Fischer and Phoenix House during December 2002. We selected the offering price in this rights offering to permit our stockholders to purchase their pro rata ownership interests in our company at the same subscription/conversion price offered to Mr. Fischer and Phoenix House in the private placement, and pursuant to the requirements of the preferred stock purchase agreement. The special committee of our Board of Directors determined the price at which a share of Series A Preferred may be converted into shares of common stock. In determining the conversion price, the special committee considered a variety of factors, including the following:
• | the historic and then-current market price of our common stock; | |
• | our business prospects; | |
• | our historical and anticipated results of operations; | |
• | general conditions in the securities markets; | |
• | our need for capital; | |
• | alternatives available to us for raising capital; | |
• | the amount of proceeds desired; | |
• | pricing of similar transactions; | |
• | the liquidity of our common stock; | |
• | the level of risk to our investors; and | |
• | the need to offer shares at a price that would be attractive to our investors relative to the current trading price of our common stock. |
As discussed in more detail above, the special committee also obtained an opinion from FTN Financial Securities Corp relating to the fairness, from a financial point of view, of the private placement to our then-existing stockholders, excluding Mr. Fischer and Phoenix House.
The subscription price should not be considered an indication of the actual value of our company or of our common stock. We cannot assure you that the market price of our common stock will not decline during or after this rights offering. We also cannot assure you that you will be able to sell shares of common stock purchased during this rights offering at a price equal to or greater than the subscription price.
Transferability of Subscription Rights
Both the basic subscription privileges and over-subscription privileges are non-transferable and non-assignable. Only you may exercise these rights.
Exercise of Subscription Rights
You may exercise your subscription rights by delivering to the subscription agent on or prior to , 2003:
• | a properly completed and duly executed subscription certificate; | |
• | any required signature guarantees; and | |
• | payment in full of $0.32 per share, whether in cash or certificates representing shares of Series A Preferred valued at $1.00 per share, for the shares of common stock subscribed for by exercising your basic subscription privileges and, if desired, your over-subscription privilege. | |
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You should deliver your subscription certificate and payment, whether in cash or in shares of Series A Preferred, to the subscription agent at the address shown under the heading “Subscription Agent.” We will not pay you interest on funds delivered to the subscription agent pursuant to the exercise of rights.
Method of Payment
If paying in cash, you must make payment for the shares by check or bank draft (cashier’s check) drawn upon a United States bank or a postal, telegraphic, or express money order payable to the order of American Stock Transfer & Trust Company as Subscription Agent. You also may make payment for basic subscription rights and over-subscription rights through wire transfer as follows:
JP Morgan Chase | |
55 Water Street | |
New York, New York 10005 | |
ABA# 021-000021 | |
Credit Account # 323-053807 | |
Account Name:American Stock Transfer & Trust Company |
Payment will be deemed to have been received by the subscription agent only upon:
• | clearance of any uncertified check; or | |
• | receipt by the subscription agent of any certified check or bank draft drawn upon a U.S. bank or of any postal, telegraphic, or express money order; or | |
• | receipt by the subscription agent of any funds transferred by wire transfer; or | |
• | receipt of funds by the subscription agent through an alternative payment method approved by us; or | |
• | receipt of a certificate representing a number of shares of Series A Preferred, valued at $1.00 per share, sufficient to satisfy the subscription price for the rights exercised. | |
Please note that funds paid by uncertified personal check may take at least five business days to clear. Accordingly, if you wish to pay by means of an uncertified personal check, we urge you to make payment sufficiently in advance of , 2003, to ensure that the payment is received and clears before that date. We also urge you to consider payment by means of a certified or cashier’s check, money order, or wire transfer.
Guaranteed Delivery Procedures
If you want to exercise your subscription rights, but time will not permit your subscription certificate to reach the subscription agent on or prior to , 2003, you may exercise your subscription rights if you satisfy the following guaranteed delivery procedures:
(1) You send, and the subscription agent receives, payment in full for each share of common stock being subscribed for through the basic subscription privilege and the over-subscription privilege, on or prior to , 2003; | |
(2) You send, and the subscription agent receives, on or prior to , 2003, a notice of guaranteed delivery, substantially in the form set forth in the instructions accompanying the subscription certificate, from a member firm of a registered national securities exchange or a member of the National Association of Securities Dealers, Inc., or a commercial bank or trust company having an office or correspondent in the United States. The notice of guaranteed delivery must state your name, the number of subscription rights that you hold, the number of shares of common stock that you wish to purchase pursuant to the basic subscription privilege and the number of shares, if any, you wish to purchase pursuant to the over-subscription privilege. The notice of guaranteed delivery must guarantee the delivery of your subscription certificate to the subscription agent within three over-the-counter trading days following the date of the notice of guaranteed delivery; and | |
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(3) You send, and the subscription agent receives, your properly completed and duly executed subscription certificate, including any required signature guarantees, within three over-the-counter trading days following the date of your notice of guaranteed delivery. |
The notice of guaranteed delivery may be delivered to the subscription agent in the same manner as your subscription certificate at the addresses set forth under the heading “Subscription Agent,” or may be transmitted to the subscription agent by facsimile transmission, to facsimile number (718) 234-5001. You can obtain additional copies of the form of notice of guaranteed delivery by requesting them from the subscription agent at the address set forth under the heading “Subscription Agent.”
Signature Guarantee
Signatures on the subscription certificate do not need to be guaranteed if either the subscription certificate provides that the shares of common stock to be purchased are to be delivered directly to the record owner of such subscription rights, or the subscription certificate is submitted for the account of a member firm of a registered national securities exchange or a member of the National Association of Securities Dealers, Inc., or a commercial bank or trust company having an office or correspondent in the United States. If a signature guarantee is required, signatures on the subscription certificate must be guaranteed by an Eligible Guarantor Institution, as defined in Rule 17Ad-15 of the Securities Exchange Act of 1934, as amended, subject to the standards and procedures adopted by the subscription agent. Eligible Guarantor Institutions include banks, brokers, dealers, credit unions, national securities exchanges, and savings associations.
Shares Held For Others
If you are a broker, a trustee, or a depository for securities, or you otherwise hold shares of common stock for the account of a beneficial owner of common stock, you should notify the beneficial owner of such shares as soon as possible to obtain instructions with respect to their subscription rights. If you are a beneficial owner of common stock held by a holder of record, such as a broker, trustee, or a depository for securities, you should contact the holder and ask the holder to effect transactions in accordance with your instructions.
Certificates for Remaining Rights After Partial Exercise
If you exercise fewer than all of the subscription rights evidenced by your subscription certificate, you may request the subscription agent to issue you a new subscription certificate evidencing the unexercised subscription rights. If you choose to have a new subscription certificate sent to you, however, we cannot assure you that you will receive the new subscription certificate in sufficient time to permit you to exercise the remaining subscription rights that the new certificate represents.
Ambiguities in Exercise of Subscription Rights
If you do not specify the number of subscription rights being exercised on your subscription certificate, or if your payment in cash or shares of Series A Preferred is not sufficient to pay the total purchase price for all of the shares that you indicated you wish to purchase, you will be deemed to have exercised the maximum number of subscription rights that could be exercised for the amount of the payment that the subscription agent receives from you. If your payment exceeds the total purchase price for all of the subscription rights shown on your subscription certificate, your payment will be applied, until depleted, to subscribe for shares of common stock in the following order:
(1) to subscribe for the number of shares, if any, that you indicated on the subscription certificate that you wish to purchase through your basic subscription privilege; | |
(2) to subscribe for shares of common stock until your basic subscription privilege has been fully exercised; | |
(3) to subscribe for additional shares of common stock pursuant to the over-subscription privilege, but subject to any applicable proration. |
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Any excess payment remaining after the foregoing allocation will be returned to you as soon as practicable by mail, without interest or deduction.
Regulatory Limitation
We will not be required to issue you shares of common stock pursuant to this rights offering if, in our opinion, you would be required to obtain prior clearance or approval from any state or federal regulatory authorities to own or control such shares if, at the time the subscription rights expire, you have not obtained such clearance or approval.
State and Foreign Securities Laws
We are not making this rights offering in any state or other jurisdiction in which it is unlawful to do so, nor are we selling or accepting any offers to purchase any shares of common stock to you if you are a resident of any such state or other jurisdiction. We may delay the commencement of this rights offering in certain states or other jurisdictions in order to comply with the securities law requirements of such states or other jurisdictions. We do not anticipate that there will be any changes in the terms of this rights offering. In our sole discretion, we may decline to make modifications to the terms of this rights offering requested by certain states or other jurisdictions, in which case stockholders that live in those states or jurisdictions will not be eligible to participate in this rights offering.
Our Decision Will Be Binding On You
We will determine all questions concerning the timeliness, validity, form, and eligibility of any exercise of subscription rights, and our determinations will be final and binding. In our sole discretion, we may waive any defect or irregularity, or permit a defect or irregularity to be corrected within such time as we may determine, or reject the purported exercise of any subscription right by reason of any defect or irregularity in such exercise. Subscriptions will not be deemed to have been received or accepted until all irregularities have been waived or cured within such time as we determine in our sole discretion. Neither we nor the subscription agent will be under any duty to notify you of any defect or irregularity in connection with the submission of a subscription certificate or incur any liability for failure to give such notification.
No Revocation
After you have exercised your basic subscription privilege or over-subscription privilege,you may not revoke that exercise. You should not exercise your subscription rights unless you are certain that you wish to purchase additional shares of common stock.
Shares of Common Stock Outstanding After the Rights Offering
There were 17,790,770 shares of common stock outstanding as of , 2003. Assuming we issue all of the shares of common stock offered in the rights offering, approximately 40,029,233 shares of common stock will be issued and outstanding. This would represent a 125% increase in the number of outstanding shares of common stock.If you do not exercise your basic subscription rights in full, your percentage ownership of our common stock will decrease if other stockholders purchase shares in the rights offering.
Fees and Expenses of Exercises
We will pay all fees charged by the subscription agent. You are responsible for paying any other commissions, fees, taxes, or other expenses incurred in connection with your exercise of the subscription rights. Neither we nor the subscription agent will pay such expenses.
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Subscription Agent
We have appointed our transfer agent, American Stock Transfer & Trust Company, as subscription agent for this rights offering. You may exercise your rights by forwarding the attached subscription documents, with payment in full of the aggregate subscription price, to the subscription agent on or prior to 5:00 p.m. Eastern Standard Time on , 2003 at either of the following addresses:
By mail: | American Stock Transfer & Trust Company Attention: Rights Agent 6201 Fifteenth Avenue, 3rd Floor Brooklyn, New York 11219 | |
By hand or overnight courier: | American Stock Transfer & Trust Company Attention: Rights Agent 59 Maiden Lane New York, New York 10038 |
The subscription agent’s telephone number is (877) 777-0800, extension 6820 and its facsimile number is (718) 234-5001. You should deliver your subscription certificate, payment of the subscription price and notice of guaranteed delivery (if any) to the subscription agent. We will pay the fees and certain expenses of the subscription agent, which we estimate will total $35,000. We also have agreed to indemnify the subscription agent from any liability that it may incur in connection with the rights offering.
IMPORTANT
Please carefully read the instructions accompanying the subscription certificate and follow those instructions in detail. Do not send subscription certificates directly to us. You are responsible for choosing the payment and delivery method for your subscription certificate, and you bear the risks associated with such delivery. If you choose to deliver your subscription certificate and payment by mail, we recommend that you use registered mail, properly insured, with return receipt requested. We also recommend that you allow a sufficient number of days to ensure delivery to the subscription agent and clearance of payment prior to , 2003. Because uncertified personal checks may take at least five business days to clear, we strongly urge you to pay, or arrange for payment, by means of certified or cashier’s check or money order.
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MATERIAL UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following summarizes the material U.S. federal income tax considerations of this rights offering to holders of our common stock who hold their subscription rights and our common stock as capital assets. This summary is based on current law, which is subject to change at any time, possibly with retroactive effect. This discussion does not address federal income tax consequences applicable to stockholders subject to special treatment under federal income tax law, including, for example, non-U.S. persons, financial institutions, dealers in securities, insurance companies, tax-exempt entities, and holders who acquired our common stock as part of a hedge, straddle, or conversion transaction. In addition, this summary does not address the tax consequences of this rights offering under applicable state, local, or foreign tax laws. This discussion assumes that you hold your shares of common stock and the subscription rights and shares issued to you during this rights offering as capital assets.
You should consult your tax advisor to determine the tax consequences to you of this rights offering in light of your particular circumstances, including any state, local, and foreign tax consequences.
Taxation of Stockholders
Receipt of a Subscription Right. You will not recognize any gain or other income upon receipt of a subscription right.
Tax Basis and Holding Period of Subscription Rights. Your tax basis in each subscription right will effectively depend on whether you exercise the subscription right or allow the subscription right to expire.
If you exercise a subscription right, your tax basis in the subscription right will be determined by allocating the tax basis of your common stock on which the subscription right is distributed between the common stock and the subscription right, in proportion to their relative fair market values on the date of distribution of the subscription right. However, if the fair market value of your subscription rights is less than 15 percent of the fair market value of your existing shares of common stock, then the tax basis of each subscription right will be deemed to be zero, unless you elect, by attaching an election statement to your federal income tax return for the taxable year in which you receive the subscription rights, to allocate tax basis to your subscription rights.
If you allow a subscription right to expire, it will be treated as having no tax basis.
Your holding period for a subscription right will include your holding period for the shares of common stock upon which the subscription right is issued.
Expiration of Subscription Rights. You will not recognize any loss upon the expiration of a subscription right.
Exercise of Subscription Rights. You generally will not recognize a gain or loss on the exercise of a subscription right. The tax basis of any share of common stock that you purchase through the rights offering will be equal to the sum of your tax basis, if any, in the subscription right exercised and the price paid for the share. The holding period of the shares of common stock purchased through the rights offering will begin on the date that you exercise your subscription rights.
Taxation of Our Company
We will not recognize any gain, other income or loss upon the issuance of the subscription rights, the lapse of the subscription rights, or the receipt of payment for shares of common stock upon exercise of the subscription rights.
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DESCRIPTION OF SECURITIES
Our authorized capital consists of 60,000,000 shares of common stock, $0.001 par value, and 5,000,000 shares of preferred stock, $.001 par value, of which 2,552,364.8 shares have been designated as Series A Redeemable Convertible Preferred Stock, $.001 par value. As of January 29, 2003, a total of 17,790,770 shares of common stock and 2,552,364.8 shares of Series A Preferred were issued and outstanding.
In addition, we have reserved the following:
• | 2,469,272 shares of common stock reserved for issuance upon exercise of stock options outstanding or available for grant under our stock options; | |
• | 7,976,140 shares of common stock reserved for issuance upon conversion of shares of Series A Preferred; and | |
• | 22,238,463 shares of common stock reserved for issuance upon exercise of rights to purchase common stock in this rights offering. | |
Common Stock
The holders of common stock are entitled to one vote per share on all matters to be voted upon by the stockholders. Subject to any preferential rights of preferred stockholders, the holders of common stock are entitled to receive dividends on a pro rata basis, if any, declared from time to time by the board of directors out of legally available funds. We have never paid dividends in the past and do not intend to do so in the future. In the event of our liquidation, dissolution, or winding up, subject to any preferential rights of preferred stockholders, the holders of common stock are entitled to share on a pro rata basis in all assets remaining after payment of liabilities. The common stock has no preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to the common stock. All outstanding shares of common stock are fully paid and nonassessable, and the shares of common stock to be issued upon completion of this rights offering will be fully paid and nonassessable.
Preferred Stock
General
Our board of directors has the authority to issue the preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions of the preferred stock, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series or the designation of any series, without further vote or action by the stockholders. The issuance of preferred stock may have the effect of delaying, deferring or preventing a change in control of our company without further action by the stockholders and may adversely affect the voting and other rights of the holders of common stock. The issuance of preferred stock with voting and conversion rights may adversely affect the voting power of the holders of common stock, including the loss of voting control to others.
Series A Redeemable Convertible Preferred Stock |
Conversion.Each share of Series A Preferred may be converted at the option of the holder at any time at an initial conversion price of $0.32 per share of common stock such that each share of Series A Preferred is initially convertible into 3.125 shares of common stock. The conversion price and the number of shares of common stock issuable upon conversion of the Series A Preferred are subject to adjustment upon the happening of certain events, such as stock dividends, distributions, and splits. In no event may the aggregate number of shares of common stock issuable upon conversion of Series A Preferred exceed 3,556,777 shares of common stock, representing 19.99% of the number of shares of common stock outstanding on the original issuance date of the Series A Preferred unless
• | our stockholders approve the issuance of all shares of common stock issuable upon conversion of the Series A Preferred at a meeting duly called for such purpose; |
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• | we obtain permission from NASDAQ to allow such issuance without any limitation on the number of shares of common stock issuable upon conversion of the shares of Series A Preferred; or | |
• | we are no longer governed by a rule promulgated by a stock exchange, NASDAQ, or other applicable body prohibiting the issuance of common stock upon conversion of the Series A Preferred in excess of 19.9% of the number of shares of common stock outstanding without stockholder approval. | |
Immediately upon the satisfaction of any of the conditions listed above, all outstanding shares of Series A Preferred will be converted automatically into the number of shares of common stock into which the shares of Series A Preferred are then convertible as of the date of the satisfaction of such condition. We have agreed with the holders of Series A Preferred that without the consent of a majority in interest of the holders of Series A Preferred, we will not hold a special meeting of stockholders or otherwise seek stockholder approval that would result in mandatory conversion of the Series A Preferred. We will not issue fractional shares of common stock upon conversion of shares of Series A Preferred, but rather will round up to the nearest whole share of common stock.
Voting.Except as otherwise required by law, holders of the Series A Preferred are entitled to vote on all matters and are entitled to that number of votes equal to the number of whole shares of common stock into which the holder’s shares of Series A Preferred could then be converted. Except as otherwise required by law or the terms of the Series A Preferred, the holders of shares of Series A Preferred and common stock vote together as a single class on all matters.
Dividends.The holders of Series A Preferred are entitled to receive a 6% cumulative annual cash dividend, which will accrue from the date of issuance and which will be payable when, as, and if declared by our Board of Directors, out of assets which are legally available for the payment of such dividends. Upon the redemption or conversion of shares of Series A Preferred, all accrued dividends with respect to such converted or redeemed shares must be paid in cash. If the holders of Series A Preferred request that we hold a special meeting of our stockholders to approve the authorization of our issuance of common stock upon conversion of the Series A Preferred in accordance with NASDAQ requirements, and if such approval has not been obtained within 120 days, the annual dividend rate will increase to 10%. We may not declare or pay cash dividends on our common stock as long as there are shares of Series A Preferred issued and outstanding.
Liquidation.In the event of any liquidation, dissolution, or winding up of our company, the holders of shares of Series A Preferred will be entitled to be paid first out of our assets available for distribution to holders of our capital stock an amount equal to $1.00 per share of Series A Preferred plus any accrued but unpaid dividends on such shares. After the liquidation preference has been paid to the holders of Series A Preferred and any other series of preferred stock designated to be senior or equal to the Series A Preferred, the remaining assets will be distributed among the holders of common stock. Any acquisition of our company, whether by merger or other form of transaction whereby our stockholders own 50% or less of the voting power of the surviving entity, or any sale of all or substantially all of our assets, will be treated as a liquidation and will entitle the holders of Series A Preferred to the liquidation preference.
Protective Provisions.For so long as at least 1,276,183 shares of Series A Preferred remain outstanding, we may not take any corporate action or otherwise amend our certificate of incorporation without the approval of at least a majority of the then outstanding shares of Series A Preferred, voting as a separate class, if such corporate action would
• | amend any of the rights, preferences, privileges of, or limitations provided for the benefit of any shares of Series A Preferred; | |
• | authorize, issue, or obligate us to authorize or issue additional shares of Series A Preferred or any shares of preferred stock that rank equal or senior to the Series A Preferred with respect to liquidation preferences, dividends, voting rights, or redemption rights; | |
• | cause us to sell shares of common stock at a price per share less than $0.32 per share, except for shares of common stock or options to purchase common stock to employees, officers, directors, or independent | |
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contractors of our company at prices or exercise prices determined by our Board of Directors to be not less than fair market value under our stock option or other benefit plans; or | ||
• | cause us to incur indebtedness for borrowed money in excess of $1.0 million. | |
Redemption.At any time after June 18, 2004, and within 30 days following the request of the holders of at least a majority of the outstanding shares of Series A Preferred, we will be required to redeem the shares of Series A Preferred at a redemption price of $1.00 per share plus all accrued and unpaid dividends on such shares. If the funds legally available for redemption are insufficient to redeem the total number of shares of Series A Preferred, we will redeem the maximum possible number of shares ratably among the holders of such shares to be redeemed. In the event we fail to redeem the shares of Series A Preferred when requested by the holders, then the holders of the then outstanding shares of Series A Preferred, voting as a separate class, with each share of Series A Preferred having one vote, will be entitled to elect a majority of our Board of Directors at the next annual meeting of stockholders or at a special meeting of the holders of Series A Preferred called for such purposes, and such directors shall continue as directors until we pay the mandatory redemption.
Registration Rights
Founders’ Registration Rights
We entered into an agreement providing registration rights for Toshiba Corporation, Phoenix House Investments, LLC, Fischer International Systems Corporation, and SCM Microsystems, Inc. If we are eligible to utilize a registration statement on Form S-3 to register an offering of our securities, holders of 20% of the shares held by Toshiba, Phoenix House, Fischer International, and SCM Microsystems may request that we file a registration statement on Form S-3, covering all or a portion of securities of SmartDisk held by them, provided that the aggregate public offering price is at least $500,000. These holders can request only two S-3 registrations. These registration rights will be subject to our right to delay the filing of a registration statement if, in the view of our board of directors, a filing would be seriously detrimental to us, not more than once in any 12-month period, for not more than 150 days after the appropriate number of holders have requested we file a registration statement.
In addition, Toshiba, Phoenix House, SCM Microsystems, and Fischer International, have “piggyback” registration rights. If we propose to register any common stock under the Securities Act, those stockholders may require us to include all or a portion of their securities in the registration. However, the managing underwriter, if any, of any offering has the right to limit the number of securities proposed to be included in the registration.
We are required to bear all registration expenses incurred in connection with these registrations. Toshiba, Phoenix House, Fischer International, and SCM Microsystems will pay all underwriting discounts and selling commissions applicable to the sale of their securities. We also agreed to indemnify Toshiba, Phoenix House, Fischer International, and SCM Microsystems for any damages they suffer due to any untrue statement or omission that we make in a registration statement covering their shares.
The registration rights of Toshiba, Phoenix House, Fischer International, and SCM Microsystems under the agreement providing registration rights will terminate, as to each of them, when it may sell all its shares in a three-month period under Rule 144 under the Securities Act.
Series A Preferred Registration Rights |
In connection with the issuance of the shares Series A Preferred, we granted to the holders of Series A Preferred certain demand registration rights commencing after the earliest of June 24, 2003, or such time as we abandon or complete this rights offering. The registration rights apply to
• | any shares of common stock acquired upon conversion of shares of Series A Preferred; | |
• | any shares of common stock acquired by the holders of Series A Preferred pursuant to a rights offering conducted by us at any time on or before December 18, 2004; and | |
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• | any shares of common stock or other company securities issued as a dividend or other distribution with respect to or in exchange for, or in replacement of, the Series A Preferred or common stock issuable upon conversion of the Series A Preferred. |
In any such event, the holders of a majority of the registrable securities then outstanding may request that we use our best efforts to file a registration statement covering the resale of at least 20% of the registrable securities then outstanding (or a lesser percentage if the aggregate offering amount would exceed $10.0 million), including the shares of common stock issuable upon conversion of the Series A Preferred. These holders may request only one registration. If the registration statement to be filed pursuant to the demand registration rights is pursuant to an underwritten offering, the managing underwriter may reduce the shares to be included in the registration if, in the judgment of the underwriter, the shares to be included would interfere with the successful marketing of the offering. These registration rights are subject to our right to delay the filing of a registration statement for a period of 75 days if, in the view of our board of directors, a filing would be seriously detrimental to us. We may not exercise this right more than once in any 12-month period.
In addition, we have granted to the holders of Series A Preferred certain “piggyback” registration rights. Under these registration rights, the holder of registrable securities may request us to register such stock if we propose to register any of our capital stock.
We will be required to bear all expenses incurred in connection with these registrations, but excluding underwriting discounts and commissions. The holders will bear the expenses of any registration withdrawn at the request of the holders unless the holders agree to forfeit their right to one demand registration.
Antitakeover Effects Of Delaware Law And Provisions Of Our Certificate Of Incorporation And Bylaws
Certificate Of Incorporation And Bylaws. Our certificate of incorporation provides that all stockholder actions must be effected at a duly called meeting and not by a consent in writing. Our certificate of incorporation also provides that the affirmative vote of 80% of our outstanding stock is required to remove any of our directors, to approve a business combination or certain other transactions between our company and a person or entity that beneficially owns 10% of our voting capital stock, or for our stockholders to amend our bylaws or the anti-takeover provisions of our certificate of incorporation. Our bylaws provide that our stockholders may not call a special meeting of stockholders. The bylaws also include advance notice procedures with regard to the nomination, other than by the board of directors, of candidates for director elections. These provisions of our certificate of incorporation and bylaws could discourage potential acquisition proposals and could delay or prevent a change in control of our company. These provisions are intended to enhance the likelihood of continuity and stability in the composition of our board of directors and in the policies formulated by our board of directors and to discourage some types of transactions that may involve an actual or threatened change of control of our company. These provisions are designed to reduce our vulnerability to an unsolicited acquisition proposal, and also are intended to discourage tactics that may be used in proxy fights. However, these provisions could have the effect of discouraging others from making tender offers for our shares or proxy fights and, as a consequence, they also may inhibit fluctuations in the market price of our shares that could result from actual or rumored takeover attempts. These provisions also may have the effect of preventing changes in our management.
Delaware Antitakeover Law. We are subject to Section 203 of the Delaware General Corporation Law, an antitakeover law. In general, Section 203 prohibits a publicly held Delaware corporation from engaging in a “business combination” with an “interested stockholder” for a period of three years following the date the person became an interested stockholder, unless the “business combination” or the transaction in which the person became an interested stockholder is approved in a prescribed manner. Generally, a “business combination” includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the interested stockholder. Generally, an “interested stockholder” is a person who, together with affiliates and associates, owns or within three years prior to the determination of interested stockholder status, did own, 15.0% or more of a corporation’s voting stock. The existence of this provision may have an antitakeover effect with respect to transactions not approved in advance by the board of directors, including discouraging attempts that might result in a premium over the market price for the shares of common stock held by stockholders.
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Transfer Agent And Registrar
The Transfer Agent and Registrar for the common stock is American Stock Transfer & Trust Company.
PLAN OF DISTRIBUTION
The rights offering will be conducted by us, and any offering to potential new investors following expiration of the rights offering will not be an underwritten offering. Our officers and directors will conduct any offering to potential new investors on our behalf. In connection with the offering, our officers and directors will not be deemed to be broker-dealers under federal and state securities laws.
On or about , 2003, we will distribute the subscription rights, subscription certificates, and copies of this prospectus to persons that owned shares of common stock on , 2003. If you wish to exercise your subscription rights and purchase shares of common stock, you should complete the subscription certificate and return it with payment for the shares, to the subscription agent, American Stock Transfer & Trust Company, at the address on page . If you have any questions, you should contact Crystal Revak, our Director, Corporate Communications, at the telephone number and address on page .
We have agreed to pay the subscription agent a fee plus certain expenses, which we estimate will total approximately $35,000. We estimate that our total expenses in connection with the rights offering will be approximately $350,000.
Before we offer shares of common stock to other potential new investors, we will consider the level of stockholder participation in the rights offering and the amount of net proceeds received from existing stockholders who exercise their subscription rights. In addition, any decision by us to offer shares to potential new investors will be based on our assessment of our capital structure, liquidity, the subscription price of common stock compared with our assessment of the underlying value of our company, and other factors.
LEGAL MATTERS
The validity of the rights and shares of common stock offered by this prospectus will be passed upon for us by Greenberg Traurig, LLP, Phoenix, Arizona. Greenberg Traurig, LLP has also advised us as to certain tax matters relating to this rights offering.
EXPERTS
Ernst & Young LLP, independent certified public accountants, have audited our consolidated financial statements and schedule at December 31, 2000 and 2001, and for each of the three years in the period ended December 31, 2001, as set forth in their report thereon (which contains an explanatory paragraph describing conditions that raise substantial doubt about the Company’s ability to continue as a going concern as described in Note 2 paragraphs 2, 3, 4, and 5 to the consolidated financial statements) appearing elsewhere herein. We have included our consolidated financial statements and schedule in this prospectus and elsewhere in the registration statement in reliance on Ernst & Young LLP’s report, given on their authority as experts in accounting and auditing.
WHERE YOU CAN OBTAIN ADDITIONAL INFORMATION
We are subject to the informational requirements of the Securities Exchange Act of 1934. Accordingly, we file reports, proxy statements, and other information with the SEC. You may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549 upon payment of the prescribed fees. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy, and information statements and other materials that are filed through the SEC’s Electronic Data Gathering, Analysis, and Retrieval, or EDGAR, system. You can access this web site at http://www.sec.gov.
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We have filed a registration statement on Form S-1 with the SEC with respect to this rights offering. This prospectus is a part of the registration statement, but does not contain all of the information included in the registration statement. You may wish to inspect the registration statement and the exhibits to that registration statement for further information with respect to our company and the securities offered in this prospectus. Copies of the registration statement and the exhibits to such registration statement are on file at the offices of the SEC and may be obtained upon payment of the prescribed fee or may be examined without charge at the public reference facilities of the SEC described above. Statements contained in this prospectus concerning the provisions of documents are necessarily summaries of the material provisions of such documents, and each statement is qualified in its entirety by reference to the copy of the applicable document filed with the SEC.
IF YOU HAVE QUESTIONS
If you have questions or need assistance concerning the procedure for exercising subscription rights or if you would like additional copies of this prospectus, the instructions, or the Notice of Guaranteed Delivery, you should contact Crystal Revak, our Director, Corporate Communications, at:
SmartDisk Corporation | |
3506 Mercantile Avenue | |
Naples, Florida 34104 | |
Telephone: (239) 436-2500 | |
Attention: Crystal Revak | |
E-mail: crystal.revak@smartdisk.com | |
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SMARTDISK CORPORATION
Page | |||||
Report of Independent Certified Public Accountants | F-2 | ||||
Consolidated Financial Statements: | |||||
Balance Sheets as of December 31, 2000 and 2001 | F-3 | ||||
Statements of Operations for the years ended December 31, 1999, 2000, and 2001 | F-4 | ||||
Statements of Cash Flows for the years ended December 31, 1999, 2000, and 2001 | F-5 | ||||
Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 1999, 2000, and 2001 | F-6 | ||||
Notes to Consolidated Financial Statements | F-7 | ||||
Schedule II — Valuation and Qualifying Accounts | F-33 | ||||
Condensed Consolidated Financial Statements: | |||||
Condensed Consolidated Balance Sheets as of June 30, 2002 (unaudited) and December 31, 2001 | F-34 | ||||
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2002 and 2001 (unaudited) | F-35 | ||||
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001 (unaudited) | F-36 | ||||
Notes to Condensed Consolidated Financial Statements (unaudited) | F-37 |
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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of SmartDisk Corporation:
We have audited the accompanying consolidated balance sheets of SmartDisk Corporation as of December 31, 2000 and 2001, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2001. Our audits also included the financial statement schedule listed in the Index. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the 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 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, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of SmartDisk Corporation as of December 31, 2000 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
The accompanying consolidated financial statements have been prepared assuming that SmartDisk Corporation will continue as a going concern. As more fully described in Note 2 paragraphs 2 and 3, the Company has incurred recurring operating losses. In addition, these operating losses have caused a significant decrease of available cash and cash equivalents. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2 paragraphs 2 and 3. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.
/s/ ERNST & YOUNG LLP |
Miami, Florida
and Note 21, as to which the date is December 31, 2002
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SMARTDISK CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, | ||||||||||
2000 | 2001 | |||||||||
(in thousands, except | ||||||||||
par value) | ||||||||||
ASSETS | ||||||||||
Current assets: | ||||||||||
Cash and cash equivalents | $ | 12,833 | $ | 14,517 | ||||||
Restricted cash | 1,671 | — | ||||||||
Short-term investments | 6,001 | — | ||||||||
Accounts receivable, net | 7,176 | 4,913 | ||||||||
Notes receivable | 28 | 11 | ||||||||
Inventories | 16,666 | 8,332 | ||||||||
Prepaid expenses and other current assets | 3,262 | 920 | ||||||||
Total current assets | 47,637 | 28,693 | ||||||||
Property and equipment, net | 3,265 | 1,869 | ||||||||
Goodwill, net | 52,110 | 2,482 | ||||||||
Other intangible assets, net | 22,988 | 2,862 | ||||||||
Deposits and other assets | 309 | 172 | ||||||||
Total Assets | $ | 126,309 | $ | 36,078 | ||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||
Current liabilities: | ||||||||||
Accounts payable | $ | 8,980 | $ | 6,019 | ||||||
Bank line of credit | 1,907 | 76 | ||||||||
Income taxes payable | 878 | 662 | ||||||||
Deferred revenue | 725 | — | ||||||||
Due to related parties | 145 | 566 | ||||||||
Other accrued liabilities | 4,865 | 2,850 | ||||||||
Total current liabilities | 17,500 | 10,173 | ||||||||
Deferred tax liabilities | 8,494 | 791 | ||||||||
Commitments and contingencies | ||||||||||
Stockholders’ equity: | ||||||||||
Preferred stock, $.001 par value; 5,000 shares authorized; none issued | — | — | ||||||||
Common stock, $.001 par value; 60,000 shares authorized; 17,596 issued and 17,509 outstanding at December 31, 2000; 17,851 issued and 17,751 outstanding at December 31, 2001 | 18 | 18 | ||||||||
Capital in excess of par value | 146,388 | 146,716 | ||||||||
Treasury stock, 87 shares at December 31, 2000 and 100 shares at December 31, 2001, at cost | (89 | ) | (99 | ) | ||||||
Accumulated other comprehensive income (loss) | 315 | (634 | ) | |||||||
Notes receivable from officers/employees | (336 | ) | (299 | ) | ||||||
Unearned compensation | — | (3 | ) | |||||||
Accumulated deficit | (45,981 | ) | (120,585 | ) | ||||||
Total stockholders’ equity | 100,315 | 25,114 | ||||||||
Total Liabilities and Stockholders’ Equity | $ | 126,309 | $ | 36,078 | ||||||
See notes to consolidated financial statements.
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SMARTDISK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended December 31, | ||||||||||||||
1999 | 2000 | 2001 | ||||||||||||
(in thousands, except | ||||||||||||||
per share amounts) | ||||||||||||||
REVENUES | ||||||||||||||
Net product sales | $ | 37,262 | $ | 94,318 | $ | 69,264 | ||||||||
Research and development | 2,587 | 1,349 | 100 | |||||||||||
License fees and royalties | 470 | 1,055 | 797 | |||||||||||
Total revenues | 40,319 | 96,722 | 70,161 | |||||||||||
COST OF REVENUES | 24,820 | 74,039 | 53,719 | |||||||||||
GROSS PROFIT | 15,499 | 22,683 | 16,442 | |||||||||||
OPERATING EXPENSES | ||||||||||||||
Research and development | 5,869 | 9,174 | 7,676 | |||||||||||
Sales and marketing | 1,608 | 6,568 | 9,223 | |||||||||||
General and administrative | 6,259 | 12,294 | 12,457 | |||||||||||
Amortization of goodwill and other acquisition related intangible assets | — | 24,691 | 25,878 | |||||||||||
Impairment of goodwill and other acquisition related intangible assets | — | — | 43,798 | |||||||||||
Total operating expenses | 13,736 | 52,727 | 99,032 | |||||||||||
OPERATING INCOME (LOSS) | 1,763 | (30,044 | ) | (82,590 | ) | |||||||||
Gain on foreign exchange | 30 | 348 | 675 | |||||||||||
Interest and other income, net | 586 | 1,473 | 257 | |||||||||||
Interest expense | (54 | ) | (112 | ) | (21 | ) | ||||||||
Net income (loss) before income taxes | 2,325 | (28,335 | ) | (81,679 | ) | |||||||||
Income tax expense (benefit) | 1,367 | (4,097 | ) | (7,075 | ) | |||||||||
NET INCOME (LOSS) | $ | 958 | $ | (24,238 | ) | $ | (74,604 | ) | ||||||
Earnings (loss) per share — basic | $ | 0.09 | $ | (1.44 | ) | $ | (4.25 | ) | ||||||
Earnings (loss) per share — diluted | $ | 0.07 | $ | (1.44 | ) | $ | (4.25 | ) | ||||||
Weighted average shares used to calculate earnings (loss) per share amounts | ||||||||||||||
Basic | 10,725 | 16,861 | 17,545 | |||||||||||
Diluted | 13,350 | 16,861 | 17,545 | |||||||||||
See notes to consolidated financial statements.
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SMARTDISK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, | ||||||||||||||||
1999 | 2000 | 2001 | ||||||||||||||
(In thousands) | ||||||||||||||||
Cash flows from operating activities: | ||||||||||||||||
Net income (loss) | $ | 958 | $ | (24,238 | ) | $ | (74,604 | ) | ||||||||
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities: | ||||||||||||||||
Depreciation of property and equipment | 1,478 | 2,183 | 2,034 | |||||||||||||
Amortization of goodwill and other intangible assets | 552 | 25,122 | 26,206 | |||||||||||||
Impairment of goodwill and other intangible assets | — | — | 43,798 | |||||||||||||
Provision for uncollectible accounts | 93 | 492 | 758 | |||||||||||||
Provision for sales returns and other credits | — | 2,439 | 1,482 | |||||||||||||
Provision for inventory obsolescence | 87 | 7,964 | 2,965 | |||||||||||||
Employee stock option expense | 76 | — | — | |||||||||||||
Deferred stock compensation | — | — | 15 | |||||||||||||
Foreign currency gain | (30 | ) | (348 | ) | (675 | ) | ||||||||||
Deferred income tax benefit | (389 | ) | (4,360 | ) | (7,621 | ) | ||||||||||
Forgiveness of note receivable | — | 180 | — | |||||||||||||
Loss on disposals of property and equipment | — | 265 | 563 | |||||||||||||
Gain on disposal of intellectual property | — | — | (150 | ) | ||||||||||||
Loss (gain) on sale of short-term investments | — | 20 | (10 | ) | ||||||||||||
Changes in assets and liabilities: | ||||||||||||||||
Accounts receivable | (1,763 | ) | (1,085 | ) | 24 | |||||||||||
Notes receivable | (4,921 | ) | 6,274 | 18 | ||||||||||||
Inventories | 128 | (7,383 | ) | 5,368 | ||||||||||||
Prepaid expenses and other current assets | (918 | ) | (1,626 | ) | 2,262 | |||||||||||
Deposits and other assets | 94 | (137 | ) | 138 | ||||||||||||
Accounts payable | 1,623 | (3,419 | ) | (2,539 | ) | |||||||||||
Income taxes payable | — | (1,697 | ) | (217 | ) | |||||||||||
Deferred revenue | 308 | 417 | (725 | ) | ||||||||||||
Other accrued liabilities | 2,432 | (79 | ) | (2,014 | ) | |||||||||||
Net cash provided by (used in) operating activities | (192 | ) | 984 | (2,924 | ) | |||||||||||
Cash flows from investing activities: | ||||||||||||||||
Purchases of property and equipment | (3,057 | ) | (1,770 | ) | (1,037 | ) | ||||||||||
Proceeds from disposals of property and equipment | — | 250 | — | |||||||||||||
Cash paid for acquisitions, net of cash acquired | — | (18,998 | ) | — | ||||||||||||
Purchases of short-term investments | (36,708 | ) | (9,117 | ) | (5,600 | ) | ||||||||||
Sales and maturities of short-term investments | 9,995 | 29,818 | 11,601 | |||||||||||||
Purchase of intangible assets | (405 | ) | — | (250 | ) | |||||||||||
Proceeds from sale of intellectual property | — | — | 150 | |||||||||||||
(Increase) decrease in restricted cash | — | (621 | ) | 1,671 | ||||||||||||
Net cash provided by (used in) investing activities | (30,175 | ) | (438 | ) | 6,535 | |||||||||||
Cash flows from financing activities: | ||||||||||||||||
Net borrowings (repayments) under line of credit | 2,647 | (7,232 | ) | (1,831 | ) | |||||||||||
Net proceeds from issuance of common stock | 43,821 | — | — | |||||||||||||
Proceeds from exercise of stock options | — | 263 | 210 | |||||||||||||
Proceeds from stock issued under ESPP | — | 473 | 100 | |||||||||||||
Proceeds from sale of stock by SDL | 65 | — | — | |||||||||||||
Collections on notes receivable from officers/employees | 30 | 51 | 37 | |||||||||||||
Purchase of treasury stock | (1 | ) | — | (10 | ) | |||||||||||
Net cash provided by (used in) financing activities | 46,562 | (6,445 | ) | (1,494 | ) | |||||||||||
Effect of exchange rate fluctuations on cash | (35 | ) | (348 | ) | (433 | ) | ||||||||||
Increase (decrease) in cash and cash equivalents | 16,160 | (6,247 | ) | 1,684 | ||||||||||||
Cash and cash equivalents at beginning of period | 2,920 | 19,080 | 12,833 | |||||||||||||
Cash and cash equivalents at end of period | $ | 19,080 | $ | 12,833 | $ | 14,517 | ||||||||||
Supplemental cash flow disclosures: | ||||||||||||||||
Issuance of common stock for business combinations | $ | — | $ | 72,958 | $ | — | ||||||||||
Conversion of stockholder loan to capital | 648 | — | — | |||||||||||||
Notes receivable obtained for stock option exercise | — | 210 | — | |||||||||||||
Forgiveness of note receivable | — | 210 | — | |||||||||||||
Issuance of common stock for intellectual property | 300 | 1,240 | — |
See notes to consolidated financial statements.
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SMARTDISK CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
Accumulated | Notes | |||||||||||||||||||||||||||||||||||||
Other | Receivable | |||||||||||||||||||||||||||||||||||||
Common Stock | Capital in | Comprehensive | From | |||||||||||||||||||||||||||||||||||
Excess of | Treasury | Income | Officers/ | Unearned | Accumulated | |||||||||||||||||||||||||||||||||
Shares | Amount | Par Value | Stock | (Loss) | Employees | Compensation | Deficit | Total | ||||||||||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||||||||||||
Balance at December 31, 1998 | 9,297 | $ | 9 | $ | 16,351 | $ | (57 | ) | $ | 479 | $ | (417 | ) | $ | — | $ | (22,701 | ) | $ | (6,336 | ) | |||||||||||||||||
Comprehensive income: | ||||||||||||||||||||||||||||||||||||||
Net income | 958 | 958 | ||||||||||||||||||||||||||||||||||||
Foreign currency translation adjustments | 277 | 277 | ||||||||||||||||||||||||||||||||||||
Unrealized loss on short-term investments | (44 | ) | (44 | ) | ||||||||||||||||||||||||||||||||||
Comprehensive income | 1,191 | |||||||||||||||||||||||||||||||||||||
Issuance of common stock in public offering, net | 3,453 | 3 | 39,170 | 39,173 | ||||||||||||||||||||||||||||||||||
Conversion of redeemable common stock | 2,487 | 3 | 9,990 | 9,993 | ||||||||||||||||||||||||||||||||||
Issuance of common stock in private placements | 650 | 1 | 4,299 | 4,300 | ||||||||||||||||||||||||||||||||||
Issuance of common stock under stock option plans | 48 | 252 | 252 | |||||||||||||||||||||||||||||||||||
Issuance of common stock under employee stock purchase plan | 15 | 171 | 171 | |||||||||||||||||||||||||||||||||||
Issuance of common stock for license | 37 | 300 | 300 | |||||||||||||||||||||||||||||||||||
Conversion of stockholder loan into SDL shares | 76 | 648 | 648 | |||||||||||||||||||||||||||||||||||
Issuance of shares by SDL | 9 | 65 | 65 | |||||||||||||||||||||||||||||||||||
Collection on notes receivable from officers/employees | 30 | 30 | ||||||||||||||||||||||||||||||||||||
Repurchase of common stock | (1 | ) | (1 | ) | ||||||||||||||||||||||||||||||||||
Balance at December 31, 1999 | 16,072 | $ | 16 | $ | 71,246 | $ | (58 | ) | $ | 712 | $ | (387 | ) | $ | — | $ | (21,743 | ) | $ | 49,786 | ||||||||||||||||||
Comprehensive loss: | ||||||||||||||||||||||||||||||||||||||
Net loss | (24,238 | ) | (24,238 | ) | ||||||||||||||||||||||||||||||||||
Foreign currency translation | (447 | ) | (447 | ) | ||||||||||||||||||||||||||||||||||
Unrealized gain on short-term investments | 50 | 50 | ||||||||||||||||||||||||||||||||||||
Comprehensive loss | (24,635 | ) | ||||||||||||||||||||||||||||||||||||
Issuance of common stock under stock option plans | 161 | 1 | 472 | 473 | ||||||||||||||||||||||||||||||||||
Issuance of common stock under employee stock purchase plan | 62 | 473 | 473 | |||||||||||||||||||||||||||||||||||
Issuance of common stock for intellectual property | 87 | 1,240 | 1,240 | |||||||||||||||||||||||||||||||||||
Acquisition of VST Technologies, Inc. | 1,089 | 1 | 69,584 | 69,585 | ||||||||||||||||||||||||||||||||||
Acquisition of Impleo Limited | 125 | 3,373 | 3,373 | |||||||||||||||||||||||||||||||||||
Collection on notes receivable from officers/employees | 51 | 51 | ||||||||||||||||||||||||||||||||||||
Repurchase of common stock | (31 | ) | (31 | ) | ||||||||||||||||||||||||||||||||||
Balance at December 31, 2000 | 17,596 | $ | 18 | $ | 146,388 | $ | (89 | ) | $ | 315 | $ | (336 | ) | $ | — | $ | (45,981 | ) | $ | 100,315 | ||||||||||||||||||
Comprehensive loss: | ||||||||||||||||||||||||||||||||||||||
Net loss | (74,604 | ) | (74,604 | ) | ||||||||||||||||||||||||||||||||||
Foreign currency translation | (943 | ) | (943 | ) | ||||||||||||||||||||||||||||||||||
Unrealized loss on short-term investments | (6 | ) | (6 | ) | ||||||||||||||||||||||||||||||||||
Comprehensive loss | (75,553 | ) | ||||||||||||||||||||||||||||||||||||
Issuance of common stock under stock option plans | 212 | 210 | 210 | |||||||||||||||||||||||||||||||||||
Issuance of common stock under employee stock purchase plan | 37 | 100 | 100 | |||||||||||||||||||||||||||||||||||
Unearned compensation: | ||||||||||||||||||||||||||||||||||||||
Issuance of common stock as compensation | 6 | 18 | (18 | ) | — | |||||||||||||||||||||||||||||||||
Amortization of unearned compensation | 15 | 15 | ||||||||||||||||||||||||||||||||||||
Collection on notes receivable from officers/employees | 37 | 37 | ||||||||||||||||||||||||||||||||||||
Repurchase of common stock | (10 | ) | (10 | ) | ||||||||||||||||||||||||||||||||||
Balance at December 31, 2001 | 17,851 | $ | 18 | $ | 146,716 | $ | (99 | ) | $ | (634 | ) | $ | (299 | ) | $ | (3 | ) | $ | (120,585 | ) | $ | 25,114 | ||||||||||||||||
See notes to consolidated financial statements.
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SMARTDISK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. | Business and Organization |
Business |
SmartDisk Corporation (“SmartDisk” or the “Company”) designs, develops, manufactures and markets personal storage and digital connectivity products that enable consumers and businesses to easily access, exchange, organize and store all types of digital content such as photographs, video, music, voice and data among digital appliances, personal computers and the Internet. The Company serves customers in the electronics and other consumer markets. Principal geographic markets for the Company’s products include the United States, Japan, Europe and other world markets.
Organization |
In March 2000, the Company acquired VST Technologies, Inc. (“VST”) to expand the Company’s product line to include USB- and FireWire-based personal storage products. In April 2000, the Company acquired Impleo Limited (“Impleo”) to increase the Company’s access to the European market. These acquisitions were recorded under the purchase method of accounting. See Note 3 for additional information on these acquisitions.
Note 2. | Summary of Significant Accounting Policies |
Basis of Presentation |
The consolidated financial statements are stated in U.S. dollars and have been prepared in accordance with accounting principles generally accepted in the United States for a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.
The Company has incurred net losses on a quarterly basis since the first quarter of 2000. The Company had cash and cash equivalents of approximately $14.5 million, $9.2 million, $4.4 million and $2.9 million as of December 31, 2001, March 31, 2002, June 30, 2002 and September 30, 2002, respectively. The Company has minimal financial resources, and its cash flow from operating activities continues to be insufficient to meet its operating needs and other payment obligations.
As part of the Company’s efforts to improve its liquidity and financial condition, during December 2002, the Company completed a private placement to the Chairman of its Board of Directors, and an entity controlled by its Chairman, who purchased from the Company an aggregate of 2,552,364.8 shares of the Company’s Series A Redeemable Convertible Preferred Stock for gross proceeds of approximately $2.5 million.
After giving effect to this investment and the implementation of the Company’s restructuring plan, and based on its current forecasted operations, the Company believes that its cash and cash equivalents and working capital will be sufficient to meet its operating requirements through December 31, 2003. However, the Company may be required to reduce its operations or to obtain additional financing if its forecast proves inaccurate for any reason, including the following: (i) the Company’s revenue fails to meet its forecast and continues to decline; (ii) the Company’s gross profit fails to meet its forecast and continues to erode; (iii) the Company’s operating expenses exceed its forecast; (iv) cash is required to collateralize letters of credit for issue to vendors or to prepay vendors for the supply of products or services; (v) cash flow from accounts receivable is reduced further or interrupted by slow collections or product returns; (vi) procurement of inventory exceeds market demand; (vii) purchase orders issued for the procurement of inventory in excess of market demand cannot be cancelled with the consequent negative impact on cash; (viii) vendors unilaterally change the payment terms under which they will supply product or services to the Company; or (ix) unanticipated events adversely effect the Company’s operations or cash flows. In addition, the Company’s
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
continued viability beyond December 31, 2003 will depend upon its ability to generate cash from operations or to obtain additional working capital. Such additional capital, if required, may not be available to the Company or may be available on terms that may be unacceptable to the Company. These liquidity problems, amongst others, raise substantial doubt about the Company’s ability to continue as a going concern.
In the first quarter of 2002, the Company began the implementation of a restructuring plan in response to a decline in demand for its products and the competitive environment in which it operates. The restructuring plan included an involuntary reduction in workforce of 21 employees across all business functions and the curtailment of operating and other expenditures. The Company has filed a registration statement to raise additional capital through a rights offering. Once the registration statement is declared effective, the Company intends to distribute to its existing shareholders rights to purchase shares of the Company’s common stock. The Company intends to use the net proceeds from the rights offering for general working capital purposes and to improve its liquidity. The Company’s ability to continue as a going concern depends upon the success of its restructuring and cost containment measures and its ability to successfully complete the rights offering. These consolidated financial statements do not include any adjustments related to the recoverability of recorded asset amounts that might be necessary as a result of the above uncertainty.
Principles of Consolidation |
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions between the companies have been eliminated.
Certain Uncertainties and Risks |
Financial instruments, which potentially subject the Company to concentrations of credit risk, consist primarily of cash and cash equivalents, short-term investments and trade receivables. The Company places its cash and cash equivalents and short-term investments with major financial institutions.
The Company sells a significant portion of its products through distributors and third-party resellers and, as a result, maintains individually significant receivable balances with major customers. If the financial condition or operations of these customers were to deteriorate, the Company’s results could be adversely affected. Credit terms to these distributors and resellers generally range from 30 to 60 days. The Company evaluates and monitors the credit worthiness of each customer on a case-by-case basis. Allowances are maintained for potential credit losses.
The Company sells to original equipment manufacturers (“OEMs”), distributors, resellers, retailers and end users in the United States, Japan, Europe and other world markets. However, large portions of the Company’s sales are to Japanese and European customers. Japanese sales as well as related expenses are denominated in Japanese yen and, accordingly, are subject to the risks associated with fluctuations in exchange rates between the Japanese yen and the U.S. dollar. European sales as well as related expenses are mostly denominated in British pounds and, accordingly, are subject to the risks associated with fluctuations in exchange rates between the British pound and the U.S. dollar. The Company does not hedge against foreign currency exposure.
Certain raw materials used by the Company in the manufacture of its products are available from a limited number of suppliers. The Company is dependent on its manufacturers to allocate a sufficient portion of their manufacturing capacity to meet the Company’s needs.
Use of Estimates |
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Foreign Currency Translation |
The functional currency of most of the Company’s wholly-owned foreign subsidiaries is the local currency. Assets and liabilities of the subsidiaries are translated to the U.S. dollar at the current exchange rates in effect at the balance sheet date with the resulting translation adjustments recorded directly to a separate component of stockholders’ equity. Revenue and expense accounts are translated using average exchange rates in effect for the period in which the items occur. Where the U.S. dollar is the functional currency or where the local currency is the functional currency and the transactions are denominated in U.S. dollars, translation adjustments are reflected in the gain (loss) on foreign exchange account included in the statement of operations.
Cash, Cash Equivalents and Short-Term Investments |
All highly liquid investments with an original maturity of three months or less when purchased are considered to be cash equivalents. All cash equivalents are carried at cost, which approximates fair value. Cash and cash equivalents include money market funds, certificates of deposit and U.S. government agency securities.
The Company has cash investment policies that limit investments to investment grade securities. Investments held by the Company are classified as “available-for-sale” as defined by Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, and are carried at fair value based on quoted market prices. Such investments consist of U.S. government agency securities, corporate debt securities and asset backed securities with original maturities beyond three months and less than twelve months. Realized losses represent the difference between the proceeds received upon sale of an investment and its amortized cost.
The Company’s realized losses during the years ended December 31, 1999 and 2000 were approximately $46,000 and $44,000, respectively. The Company realized a gain during the year ended December 31, 2001 of approximately $10,000. The Company had an unrealized gain, net of tax, as of December 31, 2000 of approximately $6,000. The Company had no unrealized gains or losses as of December 31, 2001.
The fair value of the Company’s short-term investments is as follows:
Amortized | Aggregate | Unrealized | Unrealized | ||||||||||||||
December 31, 2000 | Cost Basis | Fair Value | Gains | Losses | |||||||||||||
(In thousands) | |||||||||||||||||
U.S. government and government agency securities | $ | 4,990 | $ | 5,000 | $ | 10 | $ | — | |||||||||
Corporate bonds and notes | 1,001 | 1,001 | — | — | |||||||||||||
Total short-term investments | $ | 5,991 | $ | 6,001 | $ | 10 | $ | — | |||||||||
At December 31, 2000, the aggregate of maturities of the Company’s short-term investments were less than twelve months. The Company did not hold any short-term investments as of December 31, 2001.
Restricted Cash |
Restricted cash as of December 31, 2000 was mainly composed of a time deposit maintained by our Japanese subsidiary as collateral for a line of credit. During the year ended December 31, 2001, the subsidiary repaid substantially all of the amounts outstanding under the line of credit and transferred the restricted cash to cash and cash equivalents.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Fair Value of Other Financial Instruments |
The carrying value of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, other accrued liabilities and lines of credit approximate fair value because of the short-term maturity of these financial instruments.
Allowance for Doubtful Accounts |
The Company evaluates the collectibility of its accounts receivable based on a combination of factors. In circumstances where the Company is aware of a specific customer’s inability to meet its financial obligations to the Company (e.g., bankruptcy filings, substantive downgrading of credit scores), the Company records a specific allowance for bad debts against amounts due to reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company recognizes provisions for bad debts based on the length of time the receivables are past due. The amount of the provision is based on an evaluation of the inherent risk of collectibility at the balance sheet date. If circumstances change (i.e., higher than expected defaults or an unexpected material adverse change in a major customer’s ability to meet its financial obligations to the Company), the Company’s estimates of the recoverability of amounts due could be reduced by a material amount.
Inventories |
Inventories are stated at the lower of cost or market (estimated net realizable value), with cost being determined on a first-in, first-out basis. The Company evaluates the need for reserves based on a quarterly review of forecasted demand and market values for its products. Inventory reserves are established to the extent that the cost of the inventory exceeds the estimated market value of the inventory based on assumptions regarding future demand in relation to existing inventory balances and market conditions. Inventory reserves are applied directly to specific items. Short product life cycles are inherent in the high-technology market. Product and technology transitions announced by the Company or its competitors, delays in the availability of new products, changes in the purchasing patterns of customers and distribution partners, or adverse global economic conditions may materially affect estimates of inventory reserve requirements resulting in additional inventory write-downs.
Property and Equipment |
Property and equipment are stated at cost, less accumulated depreciation and amortization. All major expenditures for production equipment are capitalized and depreciated over the economic life of the asset. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which are approximately three years for computer and electronic equipment and software and five years for office furniture and fixtures. Depreciation and amortization of leasehold improvements is computed using the shorter of the remaining lease term or five years. In addition, certain production equipment is depreciated using the units-of production method. The units-of-production method depreciates the property over the estimated life cycle based on total production quantities. The monthly depreciation cost is calculated by using the number of pieces produced times the depreciation cost per piece computed from the estimated total production quantity. The costs of repairs and maintenance are charged to expense in the period when they are incurred.
Intangible Assets |
Intangible assets primarily consist of goodwill and separately identified intangible assets recognized in connection with the Company’s acquisitions during the year. Amortization of intangible assets is provided using the straight-line method over the assets’ estimated useful lives, which range from one to ten years.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Impairment of Long-Lived Assets |
The Company’s long-lived assets consist primarily of goodwill and other intangible assets, property and equipment and other long-term assets. SmartDisk reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Such events or circumstances include, but are not limited to, a significant decrease in the fair value of the underlying business, a significant decrease in the benefits realized from the acquired business, or a significant change in the operations of the acquired business.
Recoverability of long-lived assets is measured by comparison of the carrying amount to future discounted net cash flows the assets are expected to generate. If assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the long-lived asset exceeds its fair market value.
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, at which time certain development costs required to attain general production release would be capitalized. To date, the Company’s software development has essentially been completed concurrent with the establishment of technological feasibility, and, accordingly, no costs have been capitalized.
Income Taxes |
Deferred income tax assets and liabilities are determined based upon differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
Revenue Recognition |
The Company recognizes product revenue in accordance with the Securities and Exchange Commission’s (“SEC”) Statement of Accounting Bulletin (SAB) No. 101,Revenue Recognition in Financial Statements. The Company recognizes product revenue when title and risk of loss are transferred to customers, which is generally at the time of shipment. Title and risk of loss are transferred when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is reasonably assured. In accordance with local customs, title and risk of loss at our Japanese subsidiary is transferred to the customer upon acceptance of the product by the customer.
For customers that have a right of return, the Company records a provision for estimated product returns at the time the related revenue is recognized based historical return rates. For distributors that have a right of return and who have historically returned large amounts of product, the Company defers recognition of revenue until those distributors have sold the product. The Company also provides for price protection and other offerings that may occur under programs the Company has with its customers.
The Company accounts for the licensing of software in accordance with American Institute of Certified Public Accountants’ (AICPA) Statement of Position (SOP) 97-2,Software Revenue Recognition, as amended by SOP 98-9,Modification of SOP 97-2,Software Revenue Recognition, With Respect to Certain Transactions. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered the sales price is fixed or determinable and collectibility is reasonably assured.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Research and development revenue is recognized when earned based upon achievement of contract milestones. License fees and royalties are recognized when earned based upon terms contained in the respective contractual agreements.
Stock Based Compensation |
The Company has adopted the disclosure only provisions of SFAS No. 123, Accounting for Stock-Based Compensation. In accordance with the provisions of SFAS No. 123, the Company applies Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees, and related interpretations, to account for stock-based compensation arrangements. The Company has included the pro forma disclosures required under SFAS No. 123 in Note 12.
Shipping and Handling Costs |
Shipping and handling costs are charged to cost of sales as incurred.
Advertising |
Advertising costs are charged to expense as incurred. Advertising expenses for 1999, 2000 and 2001 were approximately $147,000, $2,503,000 and $3,603,000, respectively.
Comprehensive Income (Loss) |
Other comprehensive income (loss) refers to revenues, expenses, gains, and losses that under accounting principles generally accepted in the United States are included in comprehensive income (loss) but are excluded from net income (loss) as these amounts are recorded directly as an adjustment to stockholders’ equity, net of tax. SmartDisk’s other comprehensive income (loss) is composed of unrealized gains and losses on available-for-sale securities and foreign currency translation adjustments.
The components of other comprehensive income (loss) are as follows:
Foreign | Unrealized | ||||||||||||
Currency | Gain (Loss) on | ||||||||||||
Translation | Short term | ||||||||||||
Adjustments | Investments | Total | |||||||||||
(In thousands) | |||||||||||||
Balance at December 31, 1999 | $ | 756 | $ | (44 | ) | $ | 712 | ||||||
Foreign currency translation adjustment | (447 | ) | — | (447 | ) | ||||||||
Unrealized gain on short-term investments, net of $24 in taxes | — | 50 | 50 | ||||||||||
Balance at December 31, 2000 | 309 | 6 | 315 | ||||||||||
Foreign currency translation adjustment | (943 | ) | — | (943 | ) | ||||||||
Unrealized loss on short-term investments, net of $4 in taxes | — | (6 | ) | (6 | ) | ||||||||
Balance at December 31, 2001 | $ | (634 | ) | $ | — | $ | (634 | ) | |||||
Segment Information |
The Company reports segment data based on the management approach which designates the internal reporting that is used by management for making operating decisions and assessing performance as the source of the Company’s reportable operating segments. The Company also discloses information about products and services and geographical areas.
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Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Warranty |
The Company records a provision for product warranties upon shipment based on estimated future expenditures that will be incurred under product guarantees and warranties presently in force.
Reclassifications |
Certain amounts in the 1999 and 2000 consolidated financial statements have been reclassified to conform to the current year’s presentation. The reclassifications had no effect on previously reported net income (loss) or stockholders’ equity.
Recent Accounting Pronouncements |
In July 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141,Business Combinations, and SFAS No. 142,Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS No. 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to an assembled workforce may not be accounted for separately. The requirements of SFAS No. 141 are effective for any business combination accounted for by the purchase method that is completed after June 30, 2001. Under SFAS No. 142, goodwill and intangible assets with indefinite useful lives are no longer amortized, but are reviewed annually, or more frequently if impairment indicators arise, for impairment. SFAS No. 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The amortization provisions of SFAS No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the amortization provisions of SFAS No. 142 are effective upon adoption of SFAS No. 142. Companies are required to adopt SFAS No. 142 in their fiscal year beginning after December 15, 2001 (i.e., January 1, 2002 for calendar year companies).
Because of the extensive effort required to comply with the adoption of SFAS No. 142, it is not practicable to reasonably estimate the impact of adopting this Statement on the Company’s financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as the cumulative effect of a change in accounting principle. However, for the year ended December 31, 2001, the Company recognized approximately $9.9 million of goodwill amortization.
In October 2001, the FASB issued SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. SFAS No. 144 applies to all long-lived assets (including discontinued operations) and consequently amends APB Opinion No. 30,Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS No. 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. SFAS No. 144 is effective for the Company for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The adoption of SFAS No. 144 is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 3. Acquisitions
On March 6, 2000, SmartDisk completed its acquisition of VST Technologies, Inc. (“VST”), a Delaware corporation, located in Acton, Massachusetts, for approximately $16.4 million in cash, 1.1 million shares of SmartDisk common stock and options to acquire 443,000 shares of SmartDisk common stock. The consolidated financial statements include the operating results of VST from the date of acquisition. The following unaudited pro forma financial information reflects the VST acquisition as if it had occurred on January 1, 1999 after giving effect to certain adjustments including amortization of goodwill and other acquired intangible assets. The pro forma financial information does not purport to represent what the Company’s actual results of operations would have been had the acquisition occurred as of January 1, 1999 and may not be indicative of operating results for any future periods.
Years Ended | ||||||||
December 31, | ||||||||
1999 | 2000 | |||||||
(In thousands, except per | ||||||||
share amounts) | ||||||||
Revenues | $ | 101,845 | $ | 102,759 | ||||
Net loss | $ | (31,058 | ) | $ | (30,296 | ) | ||
Loss per share — Basic and diluted | $ | (2.63 | ) | $ | (1.69 | ) |
On April 28, 2000, SmartDisk completed its acquisition of Impleo Limited (“Impleo”), a corporation established under the laws of the United Kingdom, located in Wokingham, England, for approximately $200,000 in cash and 125,000 shares of SmartDisk common stock. This acquisition was accounted for under the purchase method of accounting. Thus, the consolidated financial statements for 2000 include the operating results of Impleo from the date of acquisition.
Note 4. Accounts Receivable
SmartDisk’s accounts receivable are reported net of allowance for doubtful accounts of approximately $705,000 and $741,000 at December 31, 2000 and 2001, respectively, and sales returns and other credits of approximately $245,000 and $458,000 at December 31, 2000 and 2001, respectively.
Note 5. Inventory
Inventories consist of the following:
December 31, | ||||||||
2000 | 2001 | |||||||
(In thousands) | ||||||||
Finished goods | $ | 6,147 | $ | 4,869 | ||||
Raw materials | 10,519 | 3,463 | ||||||
Total inventories | $ | 16,666 | $ | 8,332 | ||||
As of December 31, 2000 and 2001, approximately $503,000 and $633,000 of consigned inventory is included in finished goods, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 6. Property and Equipment
Property and equipment consists of the following:
December 31, | ||||||||
2000 | 2001 | |||||||
(In thousands) | ||||||||
Equipment | $ | 2,145 | $ | 1,982 | ||||
Tooling | 2,869 | 1,352 | ||||||
Furniture and fixtures | 603 | 624 | ||||||
Software | 984 | 999 | ||||||
Leasehold improvements | 84 | 257 | ||||||
Property and equipment, at cost | 6,685 | 5,214 | ||||||
Accumulated depreciation and amortization | (3,420 | ) | (3,345 | ) | ||||
Property and equipment, net | $ | 3,265 | $ | 1,869 | ||||
Note 7. Other Accrued Liabilities
Other accrued liabilities consist of the following:
December 31, | |||||||||
2000 | 2001 | ||||||||
(In thousands) | |||||||||
Vendor commitments | $ | 1,552 | $ | 626 | |||||
Employee compensation and benefits | 1,000 | 687 | |||||||
Other | 2,313 | 1,537 | |||||||
Total | $ | 4,865 | $ | 2,850 | |||||
Note 8. Impairment of Goodwill and Other Acquisition Related Intangible Assets
The Company continually evaluates the recoverability of its long-lived assets, such as goodwill and other acquisition related intangible assets, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of. An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered important which could trigger an impairment review include, but are not limited to, significant underperformance relative to expected historical or projected future operating results, significant changes in the manner of use of the acquired assets or the strategy for the overall business, a significant decline in the stock price for a sustained period, the market capitalization relative to net book value and significant negative industry or economic trends which indicate that this trend may continue for an indefinite period of time. If management determines that the carrying value may not be recoverable based upon the existence of one or more of the above indicators of impairment, any impairment measured is based on a projected discounted cash flow method using a discount rate commensurate with the risk inherent in the Company’s current business model.
Based on the impairment review performed for the quarter ended September 30, 2001, the Company recorded a $42.0 million impairment charge to reduce goodwill and other acquisition related intangible assets recorded in connection with the VST acquisition. In addition, based on the impairment review performed for the quarter ended December 31, 2001, the Company recorded a $1.8 million impairment charge to reduce goodwill and other acquisition related intangible assets recorded in connection with the Impleo acquisition.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
These charges were determined based upon estimated discounted future cash flows. The assumptions supporting future cash flows, including the discount rate, were determined using management’s best estimates.
Note 9. Goodwill and Other Intangible Assets
Goodwill and other intangible assets consist of the following:
December 31, | ||||||||||||
Life | 2000 | 2001 | ||||||||||
(In thousands) | ||||||||||||
Goodwill | 5 yrs. | $ | 64,928 | $ | 5,113 | |||||||
Accumulated amortization | (12,818 | ) | (2,631 | ) | ||||||||
Goodwill, net | $ | 52,110 | $ | 2,482 | ||||||||
Covenants not to compete | 2 yrs. | $ | 21,450 | $ | 21,450 | |||||||
Patents | 2-3 yrs. | 12,312 | 10,149 | |||||||||
Distribution channels | 2 yrs. | 5,100 | 200 | |||||||||
Trade names | 1-2 yrs. | 4,950 | 150 | |||||||||
Workforce in place | 4 yrs. | 1,200 | — | |||||||||
Licenses | 10 yrs. | 540 | 540 | |||||||||
Total other intangible assets | 45,552 | 32,489 | ||||||||||
Accumulated amortization | (22,564 | ) | (29,627 | ) | ||||||||
Other intangible assets, net | $ | 22,988 | $ | 2,862 | ||||||||
Note 10. Facility Closing
On May 31, 2001, the Company announced its intention to close its Acton, Massachusetts facility and move those operations into its Naples, Florida headquarters. In the connection with this closing, the Company recognized expenses of approximately $1.7 million during the year ended December 31, 2001. Total closing expenses are comprised of $0.6 million in severance costs recorded as operating expenses, approximately $0.6 million in lease cancellation costs recorded in general and administrative expenses and approximately $0.5 million in property and equipment writedowns recorded as an offset in interest and other income. The severance costs incurred in association with the closing of the facility relate to the 20 employees whose positions were eliminated. As of December 31, 2001, all facility closing activities have been completed and all related expenses have been incurred.
Note 11. Bank Line of Credit
The Company maintains a line of credit in the United States under which it may borrow up to $5.0 million subject to a borrowing base agreement, which includes not more than 90% of certain short-term investments. Any amounts borrowed under this line of credit bear interest at 2% over the 30-day LIBOR rate. The terms of this line of credit prohibit the payment of dividends on the Company’s common stock. This line of credit expires in July 2002. As of December 31, 2000 and 2001, there were no borrowings outstanding under this line of credit. However, at December 31, 2001, there was approximately $3.3 million in standby letters of credit outstanding, which were issued to certain vendors to guarantee credit terms. These standby letters of credit are not drawn on as long as vendor invoices are paid within established credit terms. As of December 31, 2001, none of the standby letters of credit had been drawn on.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
As of December 31, 2001, the Company’s wholly owned Japanese subsidiary had a line of credit with a maximum borrowing capacity of approximately $0.1 million, which was secured by accounts receivable of specified trade customers and a time deposit. The interest rate on borrowings under the credit facility is 1.875% per year and expires in January 2002. The outstanding balance under this line of credit was approximately $1.7 million and $0.1 million as of December 31, 2000 and 2001, respectively.
Interest paid during the years ended December 31, 1999, 2000 and 2001 amounted to $54,000, $112,000 and $21,000, respectively.
Note 12. | Commitments, Contingencies and Factors That May Affect Future Operations |
Leases |
The Company leases certain office and warehouse space and office equipment under various operating leases. Rent expense on operating leases for the years ending December 31, 1999, 2000 and 2001 totaled approximately $444,000, $1,090,000 and $1,169,000, respectively. The table below sets forth minimum payments for the years indicated under operating leases with remaining terms in excess of one year at December 31, 2001 (in thousands):
2002 | $ | 415,000 | |||
2003 | 69,000 | ||||
2004 | 66,000 | ||||
2005 | 59,000 | ||||
2006 | 53,000 | ||||
Thereafter | 74,000 | ||||
Total | $ | 736,000 | |||
Employment Agreements |
The Company has entered into employment agreements with certain of its employees. These agreements stipulate, among other things, severance and benefit arrangements in the event of termination. In addition, the agreements include confidentiality provisions, invention assignment provisions, and covenants not to compete.
Contingencies |
The Company relies on a combination of patents, trademarks, copyright and trade secret laws, confidentiality procedures and licensing arrangements to protect its intellectual property rights. There can be no assurance that there will not be any disputes regarding the Company’s intellectual property rights. Specifically, there can be no assurance that any patents held by the Company will not be invalidated, that patents will be issued for any of the Company’s pending applications or that any claims allowed from existing or pending patents will be of sufficient scope or strength or be issued in the primary countries where the Company’s products can be sold that will provide meaningful protection or any commercial advantage to the Company. Additionally, competitors of the Company may be able to design around the Company’s patents.
On June 26, 2000, a party filed a complaint in the Central District Federal Court of the State of California alleging SmartDisk’s infringement of a patent. The plaintiff contends that the Company’s floppy disk adapters, “FlashPath” and “Smarty” (which are no longer made by the Company) infringe the plaintiff’s patent. The Company began to sell the FlashPath products during April 1998 and continues to sell those products currently. The Company sold Smarty products beginning in April 1998. Plaintiff’s complaint seeks an undisclosed amount of damages, an injunction, and recall as well as attorneys’ fees. The plaintiff’s patent relates to a computer with a floppy diskette drive coupler that is shaped like a floppy disk and that couples to
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
and from an external end user computer peripheral device having an input/output port “normally connectable” or “traditionally connectable” to a “conventional” or “standard” computer input/output port. The Company believes that PC Connector Solutions amended its patent application claims to add the quoted limiting language after it was unsuccessful in persuading the U.S. Patent and Trademark Office to approve broader claims. The Company does not believe that it uses the claimed technology since its products do not provide the claimed coupling to an external peripheral device, nor to any peripheral device that was normally or traditionally connectable to a conventional or standard computer input/output port as of the October 1988 filing date of the plaintiff’s patent. The Company does not believe that the flash memory and smart card modules that its FlashPath and former Smarty products couple to a computer are end user peripheral devices that were “normally” or “traditionally” connectable to a “conventional” or “standard” computer input/output port on the back of a computer. On November 20, 2000, the Company prevailed in moving the venue for such action from the State of California to the Middle District of Florida. During November 2001, prior to any discovery in the litigation, the court granted a Joint Motion to Stay the litigation pending a Request for Reexamination by the U.S. Patent and Trademark Office filed by the patent owner, which has since been lifted. The Company considers this claim to be wholly without merit and will vigorously defend against such claim. Accordingly, the ultimate loss, if any, that may result cannot be reasonably determined and, accordingly, no accrual for this matter has been recorded as of December 31, 2001.
On July 26, 2001, a securities class action suit was filed against SmartDisk, the following executive officers and directors: Addison M. Fischer, Michael S. Battaglia and Michael R. Mattingly, and the following underwriters of SmartDisk’s initial public offering: FleetBoston Robertson Stephens, Inc. (formerly BancBoston Robertson Stephens, Inc.), Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. The suit was filed in the United States District Court for the Southern District of New York on behalf of all persons who acquired SmartDisk securities between October 6, 1999 and December 6, 2000. The complaint charges defendants with violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 (and Rule 10b-5 promulgated thereunder), for issuing a Registration Statement and Prospectus (“Prospectus”) that contained material misrepresentations and/or omissions. The complaint alleges that the Prospectus was false and misleading because it failed to disclose (i) the agreements between FleetBoston Robertson Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain investors to provide them with significant amounts of restricted SmartDisk shares in the initial public offering (“IPO”) in exchange for excessive and undisclosed commissions; and (ii) the agreements between FleetBoston Robertson Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain customers under which the underwriters would allocate shares in the IPO to those customers in exchange for the customers’ agreement to purchase SmartDisk shares in the after-market at pre-determined prices. The complaint seeks an undisclosed amount of damages, as well as attorney fees. SmartDisk considers this claim, as it relates to the Company, to be wholly without merit and SmartDisk will vigorously defend against such claim. Accordingly, the ultimate loss, if any, that may result cannot be reasonably determined and, accordingly, no accrual for this matter has been recorded as of December 31, 2001.
On November 30, 2001, a complaint was filed in the Southern District of New York by Dynacore Holdings Corporation and Dynacore Patent Litigation Trust alleging SmartDisk’s infringement of said parties’ patent relating to local area network (“LAN”) capabilities. The complaint seeks an undisclosed amount of damages, injunction and recall, as well as attorney fees. The Company considers this claim, as it relates to SmartDisk, to be wholly without merit and will vigorously defend against such claim. Accordingly, the ultimate loss, if any, that may result cannot be reasonably determined and, accordingly, no accrual for this matter has been recorded as of December 31, 2001.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Factors That May Affect Future Operations |
The Company participates in a highly volatile industry that is characterized by intense industry-wide competition for market share. Industry participants confront aggressive pricing practices, continually changing customer demand patterns and rapid technological developments. The Company’s operating results could be adversely affected should the Company be unable to successfully anticipate customer demand accurately, manage its product transitions, inventory levels and manufacturing processes efficiently, distribute its products quickly in response to customer demands, differentiate its products from those of its competitors or compete successfully in the markets for its new products.
Note 13. Earnings (Loss) Per Share Data
Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the year. Diluted earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding for the year plus the dilutive effect of potential common shares using the “treasury stock” method. Potential common shares for 1999 include conversion of redeemable common stock, stock options and shares of non-vested stock. Potential common shares for 2000 and 2001 include stock options and shares of non-vested stock. For the years ended December 31, 2000 and 2001, potential common shares totaling 1,323,496 and 208,240, respectively, were excluded from the computation of net loss per share because they were anti-dilutive. For the year ended December 31, 1999, potential common shares totaling 2,624,768 were included in the computation of earnings per share due to their dilutive effect.
Earnings (loss) per share has been computed reflecting the retroactive adjustment of outstanding shares related to the mergers of SDSC and SDL into SmartDisk as well as the one for four reverse stock split that was effected in August 1999.
The following table sets forth the computation of basic and diluted earnings (loss) per share:
Years Ended December 31, | |||||||||||||
1999 | 2000 | 2001 | |||||||||||
(In thousands, except | |||||||||||||
per share amounts) | |||||||||||||
Numerator: | |||||||||||||
Net income (loss) | $ | 958 | $ | (24,238 | ) | $ | (74,604 | ) | |||||
Denominator: | |||||||||||||
Weighted average shares outstanding | 10,725 | 16,861 | 17,545 | ||||||||||
Dilutive effect of conversion of redeemable Common stock | 1,901 | — | — | ||||||||||
Dilutive effect of stock options | 366 | — | — | ||||||||||
Dilutive effect of non-vested common stock | 358 | — | — | ||||||||||
Diluted shares outstanding | 13,350 | 16,861 | 17,545 | ||||||||||
Basic earnings (loss) per share | $ | 0.09 | $ | (1.44 | ) | $ | (4.25 | ) | |||||
Diluted earnings (loss) per share | $ | 0.07 | $ | (1.44 | ) | $ | (4.25 | ) | |||||
Note 14. Stockholders’ Equity
In January and July 1999, SmartDisk sold a total of 650,000 shares of its common stock in private transactions for gross proceeds of $4.3 million.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
In August 1999, the Company completed a reverse stock split of one for four. The consolidated financial statements and footnotes have been retroactively restated to reflect the reverse stock split in the prior periods, including all references in the financial statements to number of shares and per share amounts.
In August 1999, the Company amended and restated its Certificate of Incorporation such that the number of shares of authorized capital stock was increased to 65,000,000 shares, consisting of 60,000,000 shares of common stock with a par value of $0.001 per share and 5,000,000 shares of preferred stock with a par value of $0.001 per share.
On October 6, 1999, the Company completed its initial public offering (“IPO”) and realized net proceeds of approximately $39.1 million from the sale of 3,450,000 shares of common stock. Upon the successful completion of the Company’s IPO, each of the 2,487,500 outstanding shares of redeemable common stock were converted into one share of common stock.
In March 2001, SmartDisk granted 6,000 shares of common stock to an executive of the Company as a signing bonus. Unearned compensation was charged for the market value of these shares on the date of grant and is being amortized over a vesting period of one year. The unamortized unearned compensation value is shown as a reduction of stockholders’ equity. For the year ended December 31, 2001, amortization of unearned compensation was approximately $15,000.
Note 15. Stock Based Compensation
Stock Option Plans |
The Company has elected to follow APB 25 and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS No. 123 requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company’s stock options equals the market price of the underlying stock on the date of grant, no compensation expense was recognized during 1999, 2000 and 2001.
The Company’s 1998 Employee Stock Option Plan authorized the grant of options to employees including members of the Company’s Board of Directors who are employees of the Company for up to 1,454,545 shares of the Company’s common stock. Options granted under the plan are fully vested after four years and all options granted have a ten-year contractual life. This plan was terminated in July 1999 and no additional options can be granted under this plan. Of the 1,419,727 options granted under this plan, net of cancellations, 576,363 remain outstanding and the Company has reserved an equivalent amount of shares of common stock for these outstanding options.
The Company’s 1998 Directors and Consultants Stock Option Plan authorized the grant of options to officers, directors, consultants and other independent contractors (including members of the Company’s Board of Directors who are not employees of the Company) for up to 250,000 shares of the Company’s common stock. Options granted under the plan are fully vested after four years and all options granted have a ten-year contractual life. This plan was terminated in July 1999 and no additional options can be granted under this plan. Of the 212,781 options granted under this plan, net of cancellations, 139,593 remain outstanding and the Company has reserved an equivalent amount of shares of common stock for these outstanding options.
In July 1999, the Company established the 1999 Incentive Compensation Plan (the “1999 Plan”), which provides for the issuance of stock options, stock appreciation rights, restricted stock, deferred stock, other stock related awards and performance or annual incentive awards that may be settled in cash, stock or other property (collectively, the “Awards”). Pursuant to the terms of the 1999 Plan, the Company reserved 2,500,000 shares for issuance. During 2000, an additional 1,000,000 shares of common stock were reserved for issuance under the plan. Under the 1999 Plan, as amended, the total number of shares of common stock that
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
may be subject to the granting of Awards at any time during the term of the 1999 Plan shall equal 3,500,000 shares, plus the number of shares with respect to which Awards previously granted under the 1999 Plan that terminate without being exercised, and the number of shares of common stock that are surrendered in the payment of any Awards or any tax withholding requirements. In addition, the number of shares of common stock reserved and available under the 1999 Plan automatically increase on the first day of each calendar year by an amount equal to three percent of the total number of common stock outstanding on the last trading day of the immediately preceding calendar year. Accordingly, in January 2001, an additional 525,264 shares of common stock were reserved for issuance under the plan. As of December 31, 2001, net of cancellations, 2,710,311 options granted under the 1999 Plan were outstanding of which 642,086 were vested. No other form of Awards has been granted under the 1999 Plan.
During the year ended December 31, 1999, compensation expense of $76,500 was recognized relating to the accelerated vesting of 21,000 options, exercisable at $0.72 per share.
Through December 31, 2001, 1,366,861 options granted to employees and directors of SmartDisk with exercise prices ranging from $0.72 to $8.00 were immediately exercisable for cash or in part by cash (minimum par value for the shares purchased) and the balance by a five-year full recourse promissory note. Such notes would be secured by the shares purchased (to be held in escrow with no transfer rights pending full payment) with interest based on the coupon rate yield of a 52-week U.S. Treasury bill immediately preceding the execution and issuance of the promissory note, with voting rights for the underlying shares remaining with the shareholder until default, if any, on the note. Of the 1,366,861 immediately exercisable options granted, 1,098,198 options have been exercised and 108,633 have been cancelled as of December 31, 2001. Of the 1,098,198 shares of common stock issued upon exercise, 153,838 remain nonvested and 93,789 have been repurchased and are included in treasury stock in the equity section of the balance sheet. The nonvested shares of common stock will vest in accordance with the provisions of the original option award.
In September 2001, the Company announced a voluntary option exchange program for its employees. This tender offer related to an offer to all eligible individuals to exchange all outstanding options having an exercise price of $19.00 or greater for new options with an exercise price of $3.12. Options to purchase 497,750 shares of common stock were cancelled and 472,100 new options were granted. These new options vest on a quarterly basis over a three-year period starting on October 1, 2001 and are subject to variable accounting in accordance with Accounting Principles Board (“APB”) Opinion No. 25,Accounting for Stock Issued to Employees, and FASB Interpretation (“FIN”) No. 44,Accounting for Certain Transactions Involving Stock Compensation, an interpretation of APB Opinion No. 25. Accordingly, the Company has and will continue to remeasure compensation cost for these replacement options until these options are exercised, cancelled, or forfeited without replacement. As of December 31, 2001, 434,976 of the replacement options were outstanding. The amount of stock-based compensation recorded will be based on any excess of the closing stock price at the end of the reporting period or date of exercise, forfeiture or cancellation without replacement, if earlier, over the fair value of the Company’s common stock. At December 31, 2001, the fair value of the Company’s common stock was $1.15. Accordingly, the Company did not record any compensation expense associated with the replacement options during the year ended December 31, 2001.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table summarizes the status and activity of the Company’s stock option plans:
Weighted | Number of | Weighted | |||||||||||||||
Number of | Average | Options | Average | ||||||||||||||
Options | Exercise Price | Exercisable | Exercise Price | ||||||||||||||
Outstanding at December 31, 1998 | 366,000 | $ | 2.54 | 2,250 | $ | 0.72 | |||||||||||
Options granted with exercise prices equal to fair market value | 1,024,500 | 7.77 | |||||||||||||||
Exercised | (47,875 | ) | 3.67 | ||||||||||||||
Canceled | (205,875 | ) | 2.66 | ||||||||||||||
Outstanding at December 31, 1999 | 1,136,750 | $ | 7.19 | 44,794 | $ | 2.73 | |||||||||||
Options granted with exercise prices equal to fair market value | 2,766,500 | 18.55 | |||||||||||||||
Options granted with exercise prices less than fair market value | 443,248 | 1.28 | |||||||||||||||
Exercised | (160,438 | ) | 2.94 | ||||||||||||||
Canceled | (117,985 | ) | 31.08 | ||||||||||||||
Outstanding at December 31, 2000 | 4,068,075 | $ | 13.74 | 613,597 | $ | 4.12 | |||||||||||
Options granted with exercise prices equal to fair market value | 1,529,600 | 3.19 | |||||||||||||||
Exercised | (211,460 | ) | 0.99 | ||||||||||||||
Canceled | (2,015,596 | ) | 20.52 | ||||||||||||||
Outstanding at December 31, 2001 | 3,370,619 | $ | 5.70 | 1,089,233 | $ | 8.34 | |||||||||||
The 443,248 options granted during the year ended December 31, 2000 with exercise prices less than fair market value were the options exchanged as part of the VST acquisition; therefore, no compensation expense was recognized and the value of the options was included as part of the purchase consideration.
The following table summarizes information about stock options outstanding at December 31, 2001:
Outstanding Options | ||||||||||||||||||||
Exercisable Options | ||||||||||||||||||||
Weighted | ||||||||||||||||||||
Average | Weighted | Weighted | ||||||||||||||||||
Range of | Number of | Remaining | Average | Options | Average | |||||||||||||||
Exercise Prices | Options | Contractual Life | Exercise Price | Exercisable | Exercise Price | |||||||||||||||
$ 0.72 - $ 1.15 | 87,479 | 7.9 years | $ | 0.89 | 82,292 | $ | 0.88 | |||||||||||||
$ 1.41 - $ 2.17 | 146,369 | 9.3 years | 1.64 | 47,369 | 1.97 | |||||||||||||||
$ 2.55 - $ 3.51 | 1,097,304 | 9.5 years | 3.09 | 52,036 | 3.02 | |||||||||||||||
$ 4.00 - $ 5.38 | 1,367,676 | 8.6 years | 5.01 | 494,381 | 5.02 | |||||||||||||||
$ 8.00 - $14.38 | 573,283 | 7.5 years | 8.28 | 323,960 | 8.29 | |||||||||||||||
$21.19 - $31.63 | 4,532 | 8.5 years | 27.11 | 4,532 | 27.11 | |||||||||||||||
$35.00 - $47.25 | 93,976 | 8.1 years | 40.42 | 84,663 | 41.00 | |||||||||||||||
$ 0.72 - $47.25 | 3,370,619 | 8.7 years | $ | 5.70 | 1,089,233 | $ | 8.34 | |||||||||||||
Employee Stock Purchase Plan
In July 1999, the Company established the 1999 Employee Stock Purchase Plan (the “Purchase Plan”), for which 465,000 shares of the Company’s common stock have been reserved. Eligible employees may
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
purchase a limited number of shares of the Company’s common stock at 85% of the market value at certain plan-defined dates. For the years ended December 31, 1999, 2000 and 2001, the Company issued 15,411, 62,307 and 37,348 shares of common stock, respectively, under the Purchase Plan. At December 31, 2001, 349,934 shares of common stock were available for issuance under the Purchase Plan.
Pro Forma Information for Stock-Based Compensation
Pro forma information regarding net income (loss) and earnings (loss) per share is required by SFAS No. 123, and has been determined as if the Company had accounted for its employee stock options and employee stock purchase plan under the fair value method of that Statement. For the fair value disclosure below, compensation value is estimated for each option grant using a Black-Scholes option-pricing model. The following weighted average assumptions were used for option grants in 1999, 2000 and 2001: weighted average risk-free interest rate of 5.75%, 5.93% and 4.19% in 1999, 2000 and 2001, respectively; expected dividend yield of 0% for all years; volatility factor of the expected market price of the Company’s common stock of zero for the period in 1999 prior to the Company’s IPO, 0.80 for the period in 1999 following the Company’s IPO, 1.42 for 2000 and 1.298 for 2001; and an expected life of the options of 3 years for all years. Shares issued under the Purchase Plan during 2000 and 2001 were valued with a minimum value pricing model using the following assumptions: weighted average risk-free interest rate of 6.50% and 4.41%, respectively, expected dividend yield of 0% and a life of six months for both years.
The weighted average grant date fair value of options granted during the years ended December 31, 1999, 2000 and 2001 with exercise prices equal to market value was $5.11, $14.89 and $1.70, respectively. There were no options granted during the years ended December 31, 1999 and 2001 with exercise prices less than market value and the options issued in 2000 at exercise prices less than market value were those exchanged as part of the VST acquisition. The weighted average grant date fair value of the shares issued under the Purchase Plan during 2000 and 2001 was $10.88 and $2.08, respectively.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different than those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee’s stock options.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
For purposes of pro forma disclosures, the estimated fair value of options is amortized to expense over the options’ vesting period. The Company’s pro forma information for options granted, excluding those exchanged in the VST acquisition, is as follows:
Years Ended December 31, | |||||||||||||
1999 | 2000 | 2001 | |||||||||||
(In thousands, except | |||||||||||||
per share amounts) | |||||||||||||
Net income (loss): | |||||||||||||
As reported | $ | 958 | $ | (24,238 | ) | $ | (74,604 | ) | |||||
Pro forma | $ | 754 | $ | (32,102 | ) | $ | (80,540 | ) | |||||
Basic net income (loss) per share: | |||||||||||||
As reported | $ | 0.09 | $ | (1.44 | ) | $ | (4.25 | ) | |||||
Pro forma | $ | 0.07 | $ | (1.90 | ) | $ | (4.59 | ) | |||||
Diluted net income (loss) per share: | |||||||||||||
As reported | $ | 0.07 | $ | (1.44 | ) | $ | (4.25 | ) | |||||
Pro forma | $ | 0.06 | $ | (1.90 | ) | $ | (4.59 | ) | |||||
The effects of applying SFAS No. 123 on pro forma disclosures of net income (loss) and earnings (loss) per share for 1999, 2000 and 2001 are not likely to be representative of the pro forma effects on net income (loss) and earnings (loss) per share in future years because the number of shares to be issued under these plans is not known and the assumptions used to determine the fair value can vary significantly.
Note 16. Employee Benefit Plans
The Company has two defined contribution plans. One of the plans was assumed in 2000 upon the acquisition of VST (the “VST Plan”). The VST Plan was offered to employees of the Company’s wholly owned subsidiary, SmartDisk Personal Storage Systems Corporation. As a result of the closing of the Company’s Acton, Massachusetts operations, contributions into the VST Plan were discontinued as of October 1, 2001. All other U.S.-based employees may elect to participate in the SmartDisk Plan. Qualified employees may elect to make pre tax contributions into the plans for up to 15% of their annual compensation, up to a maximum of $10,500 per year. The Company’s matching contributions are earned by the employee based on a straight line, five-year vesting schedule for participants in the SmartDisk Plan and straight line, three-year vesting schedule for participants in the VST Plan. The Company may make additional annual contributions to the plans at the discretion of the Board of Directors. For the years ended December 31, 1999, 2000 and 2001, the Company made matching contributions of approximately $31,000, $130,000 and $140,000, respectively, to these plans.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 17. Income Taxes
The United States and foreign components of income (loss) from continuing operations before income taxes are as follows:
Years Ended December 31, | |||||||||||||
1999 | 2000 | 2001 | |||||||||||
(In thousands) | |||||||||||||
United States | $ | 553 | $ | (32,437 | ) | $ | (83,701 | ) | |||||
Foreign | 1,772 | 4,102 | 2,022 | ||||||||||
Total | $ | 2,325 | $ | (28,335 | ) | $ | (81,679 | ) | |||||
The income tax benefit for 2000 and 2001 as presented in the statements of operations relates to the reduction of the deferred income tax liability associated with the identified intangible assets. The components of the income tax provision (benefit) are as follows:
Years Ended December 31, | |||||||||||||
1999 | 2000 | 2001 | |||||||||||
(In thousands) | |||||||||||||
Current: | |||||||||||||
United States | $ | 60 | $ | (225 | ) | $ | 39 | ||||||
Foreign | 1,696 | 1,528 | 507 | ||||||||||
Total current expense | 1,756 | 1,303 | 546 | ||||||||||
Deferred: | |||||||||||||
United States | (50 | ) | (5,531 | ) | (7,663 | ) | |||||||
Foreign | (339 | ) | 131 | 42 | |||||||||
Total deferred benefit | (389 | ) | (5,400 | ) | (7,621 | ) | |||||||
Income tax provision (benefit) | $ | 1,367 | $ | (4,097 | ) | $ | (7,075 | ) | |||||
The Company made income tax payments of approximately $145,000, $1.5 million and $87,000 during 1999, 2000 and 2001, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The significant components of the Company’s deferred income taxes are as follows:
December 31, | ||||||||||
2000 | 2001 | |||||||||
(In thousands) | ||||||||||
Deferred tax assets: | ||||||||||
Current: | ||||||||||
Accrued expenses | $ | 135 | $ | 333 | ||||||
Bad debt and inventory reserves | 2,698 | 743 | ||||||||
Non-current: | ||||||||||
Net operating loss carryforwards | 1,787 | 4,460 | ||||||||
Depreciation and amortization | 27 | 31 | ||||||||
Tax credits | 1,759 | 3,436 | ||||||||
Foreign deferred tax asset | 105 | 50 | ||||||||
Other | (29 | ) | 213 | |||||||
Deferred tax assets | 6,482 | 9,266 | ||||||||
Less: valuation allowance | (6,377 | ) | (9,216 | ) | ||||||
Net deferred tax assets | 105 | 50 | ||||||||
Deferred tax liabilities: | ||||||||||
Acquired intangibles | (8,494 | ) | (791 | ) | ||||||
Net deferred taxes | $ | (8,389 | ) | $ | (741 | ) | ||||
The reconciliation of the U.S. federal statutory income tax rate to the effective income tax rate is:
Years Ended December 31, | |||||||||||||
1999 | 2000 | 2001 | |||||||||||
Federal income tax benefit | 34.00 | % | (34.00 | )% | (34.00 | )% | |||||||
State taxes, net of federal benefit | 3.57 | (1.93 | ) | (1.21 | ) | ||||||||
Foreign tax rate differential | (0.33 | ) | (3.33 | ) | (0.90 | ) | |||||||
Non-deductible items | 0.56 | 0.06 | 0.38 | ||||||||||
Goodwill | 1.83 | 11.27 | 20.52 | ||||||||||
Change in valuation allowance | 19.48 | 9.94 | 3.39 | ||||||||||
Other | (0.32 | ) | 1.71 | 2.55 | |||||||||
Total | 58.79 | % | (16.28 | )% | (9.27 | )% | |||||||
SFAS No. 109,Accounting for Income Taxes, requires a valuation allowance to reduce the deferred tax assets reported if, based on the weight of the evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. After consideration of all the evidence, both positive and negative, management has determined that a valuation, allowance of approximately $6,377,000 and $9,216,000 at December 31, 2000 and 2001, respectively, is necessary to reduce the deferred tax assets to the amount that will more likely than not be realized. The change in valuation allowance amounted to approximately $774,000, $2,960,000 and $2,839,000 for the years ended December 31, 1999, 2000 and 2001, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
At December 31, 2000 and 2001, the carryforwards for tax purposes as follows:
December 31, 2000 | December 31, 2001 | |||||||||||||||
Amount | Expiration | Amount | Expiration | |||||||||||||
(Amounts in thousands) | ||||||||||||||||
Jurisdiction | ||||||||||||||||
United States | $ | 3,521 | 2018 | $ | 11,852 | 2018 | ||||||||||
United Kingdom | 1,539 | Unlimited | 1,539 | Unlimited |
At December 31, 2000 and 2001, the Company had United States tax credit carryforwards as follows:
December 31, 2000 | December 31, 2001 | |||||||||||||||
Amount | Expiration | Amount | Expiration | |||||||||||||
(Amounts in thousands) | ||||||||||||||||
Tax Credit | ||||||||||||||||
Foreign tax credit | $ | 1,700 | 2004 | $ | 2,608 | 2004 | ||||||||||
Alternative minimum tax credit | 59 | Unlimited | 64 | Unlimited | ||||||||||||
R&D tax credit | — | — | 784 | 2018 |
Undistributed earnings of the Company’s foreign subsidiaries are considered to be permanently invested; therefore, in accordance with SFAS No. 109, no provision for U.S. Federal and state income taxes on those earnings have been provided. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income tax liability (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. However, unrecognized foreign tax credit carryforwards would be available to reduce some portion of the U.S. liability.
Note 18. Segment Information
Based on its method of internal reporting, SmartDisk has two reportable segments: personal storage products and digital connectivity products. Personal storage products primarily consist of the family of Universal Serial Bus (“USB”) and FireWire-based products, which include high performance, portable hard disk drives and floppy disk drives for desktop and notebook PCs, portable CD-R/W drives, as well as expansion-bay disk drives for notebook PCs. Digital connectivity products primarily consist of the Company’s FlashPath flash memory card readers, which support Toshiba SmartMedia, Sony Memory Stick, and SanDisk MultiMediaCard.
The accounting policies for each of the segments are the same as those described in the summary of significant accounting policies. There are no intersegment revenues. SmartDisk does not allocate operating expenses, interest expense and other income, net or income tax expense or benefit to these segments for internal reporting purposes.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following table presents information about the Company’s operations for its reportable segments:
Years Ended December 31, | |||||||||||||
1999 | 2000 | 2001 | |||||||||||
(In thousands) | |||||||||||||
Personal storage products: | |||||||||||||
Revenues | $ | — | $ | 49,832 | $ | 43,842 | |||||||
Gross profit | $ | — | $ | 6,196 | $ | 7,730 | |||||||
Digital connectivity products: | |||||||||||||
Revenues | $ | 37,262 | $ | 44,486 | $ | 25,422 | |||||||
Gross profit | $ | 12,468 | $ | 14,403 | $ | 8,123 | |||||||
Other: | |||||||||||||
Revenues | $ | 3,057 | $ | 2,404 | $ | 897 | |||||||
Gross profit | $ | 3,031 | $ | 2,084 | $ | 589 | |||||||
Total | |||||||||||||
Revenues | $ | 40,319 | $ | 96,722 | $ | 70,161 | |||||||
Gross profit | $ | 15,499 | $ | 22,683 | $ | 16,442 | |||||||
Sales to foreign markets and to significant customers as a percentage of the Company’s total revenues were as follows:
Years Ended December 31, | |||||||||||||
1999 | 2000 | 2001 | |||||||||||
Foreign markets: | |||||||||||||
United States | 15 | % | 57 | % | 60 | % | |||||||
Asia and Pacific Rim | 81 | 37 | 29 | ||||||||||
Europe | 4 | 6 | 11 |
Years Ended December 31, | |||||||||||||
1999 | 2000 | 2001 | |||||||||||
Significant Customers: | |||||||||||||
Apple | — | % | 10 | % | 22 | % | |||||||
FISC | 10 | — | — | ||||||||||
FujiFilm | 28 | 7 | 3 | ||||||||||
Ingram Micro | — | 18 | 24 | ||||||||||
Olympus | 27 | 6 | 4 | ||||||||||
Sony | 10 | 15 | 16 |
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The following is a summary of the carrying amounts of the Company’s net assets by geographic area in which they are located:
December 31, | |||||||||
2000 | 2001 | ||||||||
(In thousands) | |||||||||
United States | $ | 93,785 | $ | 18,748 | |||||
Asia and Pacific Rim | 4,723 | 2,570 | |||||||
Europe | 1,807 | 3,796 | |||||||
Total | $ | 100,315 | $ | 25,114 | |||||
The following is a summary of the Company’s long-lived assets by geographic area in which they are located:
December 31, | |||||||||
2000 | 2001 | ||||||||
(In thousands) | |||||||||
United States | $ | 77,883 | $ | 6,934 | |||||
Asia and Pacific Rim | 713 | 216 | |||||||
Europe | 76 | 235 | |||||||
Total | $ | 78,672 | $ | 7,385 | |||||
Note 19. Related Party Transactions
Material related party transactions that have been entered into by the Company that are not disclosed otherwise in these notes are summarized below.
In the ordinary course of business, SmartDisk engages in transactions with certain of its shareholders. These transactions are comprised of sales of the Company’s finished goods and purchases of raw materials under usual trade terms and measured at their exchange amounts. In addition, the Company procures certain engineering services from a strategic investor. Transactions with related parties for the three years ended December 31, 2001 are as follows:
Years Ended December 31, | ||||||||||||
1999 | 2000 | 2001 | ||||||||||
(In thousands) | ||||||||||||
Revenues | $ | 5,021 | $ | 596 | $ | 100 | ||||||
Purchases | $ | — | $ | — | $ | 1,331 | ||||||
Services | $ | 428 | $ | 338 | $ | 236 |
SmartDisk was incorporated in March 1997, and its predecessor, SmartDisk Security Corporation (“SDSC”) was incorporated in May 1993. SDSC was substantially wholly-owned by Addison Fischer (“Fischer”). From 1993 to 1995, SDSC exploited technology that it licensed under a manufacturing license agreement with Fischer International Systems Corporation (“FISC”), another company substantially wholly-owned by Fischer. The license agreement covered the manufacture and sale of solid-state diskettes relating to the fields of data security and validation and computer security and access control. The patents underlying the licensed technology were held by SmartDiskette GmbH (“SDG”), a German company that is wholly-owned by SmartDiskette Limited (“SDL”), an English company that was approximately 37% owned by Fischer until May 1996. SDG licensed these patents to SDL. SDL in turn entered into a manufacturing license agreement with FISC that FISC subsequently assigned to SDSC. In May 1996, Fischer increased his ownership of SDL to 87% and the accounts of SDL were adjusted as of that date to reflect a new basis under the purchase
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
method of accounting. In May 1997, Fischer increased his ownership of SDL to 92%. In May 1998, Phoenix House Investments, LLC (“Phoenix House”), an investment company substantially owned by Fischer, acquired the remaining outstanding interests of SDL through the issuance of common stock valued at approximately $300,000. In May 1999, the stockholders of SDL exchanged all their shares of SDL for 515,500 shares of common stock of SmartDisk and SDL became a wholly owned subsidiary of SmartDisk. The merger was a combination of entities under common control and accounted for at historical cost. The individual financial statements of SmartDisk and SDL are combined in the accompanying financial statements from May 1996, the point in time SDL came under common control.
Pursuant to operating agreements entered into in 1998, FISC provides operating assistance to the Company consisting of services, facilities and shared equipment. The Company’s share of expenses for these services is based on an internal analysis of the relative amount of time devoted to its business by employees of FISC as well as the overhead charges attributable to these employees. In the opinion of management, the allocations were reasonable and represent the Company’s cost of doing business. The Company recorded operating expenses related to these agreements for the years ended December 31, 1999, 2000 and 2001 of approximately $0.3 million, $0.2 million and $0.2 million, respectively.
In 1998, the Company was granted a non-exclusive license agreement to certain patents relating to the interface with Toshiba’s SmartMedia cards. In April 1999, the license agreement was amended whereby Toshiba granted the Company a fully paid license at which time the Company stopped paying royalties. Prior to this, the Company paid a one-half of one percent royalty on the net sales price of the Company’s products that use the Toshiba license. In 1999, the Company paid royalty expenses pertaining to this license of approximately $26,000.
Pursuant to a license and distribution agreement entered into in 1998 between FISC and the Company, FISC was granted the right to license and distribute certain of the Company’s products. For this right, FISC agreed to pay to the Company royalties of 33.3% of net revenue derived from those product sales. This agreement was discontinued in July 2000. Under this agreement, FISC paid royalties of approximately $470,000 and $71,000 during the years ended December 31, 1999 and 2000, respectively. During 2000, FISC represented SmartDisk in a transaction to license the Company’s SafeBoot product. The Company incurred expenses of approximately $290,000 for FISC’s services in connection with this transaction.
During February 1999, the Company loaned $60,000 to one of its officers. The loan was made pursuant to a Promissory Note, bears interest at 4.71%, and is repayable in four annual installments of principal and interest. As of December 31, 2000, the balance outstanding on this loan was $45,000. This loan was repaid in full during 2001.
The Company has, in conjunction with the 1998 Employee Stock Option Plan, made loans to several of its employees to allow for the immediate exercise of stock option grants. Each loan was made pursuant to a full recourse Promissory Note, is secured by a pledge of the shares of stock, which the employee has acquired, bears interest at approximately 5.5%, which is payable quarterly, and is required to be paid in full within five years of the date of issuance. As of December 31, 2000 and 2001, the principal amount due under these loans was approximately $336,000 and $299,000, respectively.
In January 2000, a director of SmartDisk exercised 6,000 stock options with an exercise price of $35.00 per option. The director executed a $210,000 full recourse promissory note with the Company as payment for these shares. The Company repurchased these shares in November 2000 for $30,000 and the remaining $180,000 balance on the note was forgiven and recognized as compensation expense. The repurchased shares are included in treasury stock in the equity section of the balance sheet.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Note 20. Research and Development Contract Revenues
During 1999, SmartDisk entered into and completed various research and development contracts with a technology company. The contracts entitled the Company to invoice and receive funds over the development period, some of which were conditioned upon acceptance of certain deliverables. Through December 31, 1999, SmartDisk invoiced approximately $2.6 million for development work. All of these revenues were recognized as income in the fourth quarter of 1999 upon the technology company’s final acceptance of the product. Approximately $1.6 million of contract costs were charged to expense over the life of the development periods, which ended in 1999.
As of December 31, 1999, SmartDisk had an ongoing research and development contract. This contract entitled SmartDisk to invoice and receive funds over the development period based upon the customer’s acceptance of certain deliverables. During 2000, SmartDisk recognized as income approximately $1.2 million related to this development contract. Approximately $0.5 million and $0.5 million of contract costs related to this development contract were charged to expense as of December 31, 1999 and 2000, respectively.
During 2000, SmartDisk entered into a research and development contract. This contract entitled SmartDisk to invoice and receive funds over the development period based upon the customer’s acceptance of certain deliverables. During 2000 and 2001, SmartDisk recognized as income approximately $0.1 million and $0.1 million, respectively, related to this development contract. Approximately $25,000 and $15,000 of contract costs related to this development contract were charged to expense during the years ended December 31, 2000 and 2001, respectively.
Note 21. Subsequent Event
On December 24, 2002, Addison Fischer, Chairman of the Company’s Board of Directors, and Phoenix House Investments, LP, an entity controlled by Mr. Fischer, purchased from the Company an aggregate of 2,552,364.8 shares of the Company’s Series A Redeemable Convertible Preferred Stock for gross proceeds of approximately $2.5 million. Each share of Series A Preferred is convertible into shares of common stock at an initial conversion price of $0.32 per share of common stock such that each share of Series A Preferred is initially convertible into 3.125 shares of common stock.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The table below sets forth selected unaudited financial data for each quarter of the most recent two years:
Three Months Ended | |||||||||||||||||
March 31 | June 30 | September 30 | December 31 | ||||||||||||||
(In thousands, except per share amounts) | |||||||||||||||||
2000 | |||||||||||||||||
Revenues(1) | $ | 17,383 | $ | 30,928 | $ | 32,708 | $ | 15,703 | |||||||||
Gross profit (loss)(2) | 6,053 | 9,448 | 10,046 | (2,864 | ) | ||||||||||||
Net loss | (503 | ) | (4,272 | ) | (3,912 | ) | (15,551 | ) | |||||||||
Loss per share(3) | |||||||||||||||||
Basic and diluted | $ | (0.03 | ) | $ | (0.25 | ) | $ | (0.23 | ) | $ | (0.90 | ) | |||||
2001 | |||||||||||||||||
Revenues(4) | $ | 17,262 | $ | 20,675 | $ | 17,323 | $ | 14,901 | |||||||||
Gross profit | 4,833 | 5,242 | 3,490 | 2,877 | |||||||||||||
Net loss(5)(6) | (8,381 | ) | (8,184 | ) | (51,263 | ) | (6,776 | ) | |||||||||
Loss per share(3) | |||||||||||||||||
Basic and diluted | $ | (0.48 | ) | $ | (0.47 | ) | $ | (2.91 | ) | $ | (0.38 | ) |
(1) | Revenues in the fourth quarter of 2000 reflect a decline in sales of the Company’s personal storage products. In addition, the Company is experiencing a decrease in demand for its FlashPath products due to the anticipated decrease in the use of the 3.5-inch floppy drive. |
(2) | Gross profit (loss) in the fourth quarter of 2000 reflects approximately $5.2 million of inventory writedowns arising from the decrease in the demand for the Company’s personal storage products, as well as approximately $0.5 million in inventory writedowns associated with the Company’s Smarty product due to the Company’s discontinuance of that product line. |
(3) | Earnings (loss) per share for each quarter is computed using the weighted-average number of shares outstanding during that quarter while earnings (loss) per share for the full year is computed using the weighted-average number of shares outstanding during the year. Thus, the sum of the four quarters’ earnings (loss) per share may not equal the full-year earnings (loss) per share. |
(4) | Revenues in the third and fourth quarters of 2001 reflect a decline in sales of the Company’s products due to the decline in demand arising from a continued weakness in the worldwide economy as well as the Company’s transition to more traditional distribution channels such as retail. In addition, the Company is experiencing a decrease in demand for its FlashPath products due to the anticipated decrease in the use of the 3.5-inch floppy drive. |
(5) | Net loss in the third quarter of 2001 reflects approximately $40.5 million, net of tax, of impairment charge to reduce the goodwill and other acquisition related intangible assets recorded in connection with the VST acquisition. |
(6) | Net loss in the fourth quarter of 2001 reflects approximately $1.7 million, net of tax, of impairment charge to reduce the goodwill and other acquisition related intangible assets recorded in connection with the Impleo acquisition. |
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SMARTDISK CORPORATION
SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS
Balance at | Charged to | Charged to | Balance at | ||||||||||||||||||
Beginning | Costs and | Other | End | ||||||||||||||||||
Classification | of Period | Expenses | Accounts | Deductions | of Period | ||||||||||||||||
YEAR ENDED DECEMBER 31, 1999 | |||||||||||||||||||||
Reserves and allowances deducted from asset accounts: | |||||||||||||||||||||
Allowance for doubtful accounts | $ | 34 | $ | 106 | $ | — | $ | — | $ | 140 | |||||||||||
Valuation allowance for deferred tax asset | 2,643 | 774 | — | — | 3,417 | ||||||||||||||||
$ | 2,677 | $ | 880 | $ | — | — | $ | 3,557 | |||||||||||||
YEAR ENDED DECEMBER 31, 2000: | |||||||||||||||||||||
Reserves and allowances deducted from asset accounts: | |||||||||||||||||||||
Allowance for doubtful accounts | $ | 140 | $ | 603 | $ | — | $ | 38 | $ | 705 | |||||||||||
Allowance for sales returns and other credits | — | 2,439 | — | 2,194 | 245 | ||||||||||||||||
Valuation allowance for deferred tax asset | 3,417 | 2,960 | — | — | 6,377 | ||||||||||||||||
$ | 3,557 | $ | 6,002 | $ | — | $ | 2,232 | $ | 7,327 | ||||||||||||
YEAR ENDED DECEMBER 31, 2001: | |||||||||||||||||||||
Reserves and allowances deducted from asset accounts: | |||||||||||||||||||||
Allowance for doubtful accounts | $ | 705 | $ | 758 | $ | — | $ | 722 | $ | 741 | |||||||||||
Allowance for sales returns and other credits | 245 | 1,482 | — | 1,269 | 458 | ||||||||||||||||
Valuation allowance for deferred tax asset | 6,377 | 2,839 | — | — | 9,216 | ||||||||||||||||
$ | 7,327 | $ | 5,079 | $ | — | $ | 1,991 | $ | 10,415 | ||||||||||||
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SMARTDISK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
September 30, | ||||||
2002 | ||||||
(In thousands, | ||||||
except par | ||||||
value) | ||||||
(Unaudited) | ||||||
ASSETS | ||||||
Current assets: | ||||||
Cash and cash equivalents | $ | 2,862 | ||||
Restricted cash | 2,107 | |||||
Accounts and notes receivable, net | 3,978 | |||||
Inventories | 6,687 | |||||
Prepaid expenses and other current assets | 1,744 | |||||
Total current assets | 17,378 | |||||
Property and equipment, net | 1,179 | |||||
Goodwill and other intangible assets, net | 156 | |||||
Deposits and other assets | 201 | |||||
TOTAL ASSETS | $ | 18,914 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||
Current liabilities: | ||||||
Accounts payable | $ | 6,286 | ||||
Bank line of credit | — | |||||
Income taxes payable | 262 | |||||
Other accrued liabilities | 2,371 | |||||
Total current liabilities | 8,919 | |||||
Deferred income taxes and other | — | |||||
Commitments and contingencies | ||||||
Stockholders’ equity: | ||||||
Preferred stock, $0.001 par value; 5,000 shares authorized; none issued | — | |||||
Common stock, $0.001 par value; 60,000 shares authorized; 17,884 issued and 17,784 outstanding at June 30, 2002; 17,851 issued and 17,751 outstanding at December 31, 2001 | 18 | |||||
Capital in excess of par value | 146,752 | |||||
Treasury stock, 100 shares at June 30, 2002 and December 31, 2001, at cost | (99 | ) | ||||
Accumulated other comprehensive loss | (52 | ) | ||||
Notes receivable from officers/employees | (295 | ) | ||||
Unearned compensation | — | |||||
Accumulated deficit | (136,329 | ) | ||||
Total stockholders’ equity | 9,995 | |||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 18,914 | ||||
See accompanying notes to condensed consolidated financial statements.
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SMARTDISK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended | Nine Months Ended | |||||||||||||||||
September 30, | September 30, | |||||||||||||||||
2002 | 2001 | 2002 | 2001 | |||||||||||||||
(In thousands, except per share amounts) | ||||||||||||||||||
(Unaudited) | ||||||||||||||||||
Revenues: | ||||||||||||||||||
Product sales, net | $ | 10,336 | $ | 17,323 | $ | 31,042 | $ | 54,363 | ||||||||||
Research and development revenue | — | — | — | 100 | ||||||||||||||
Royalty income and license fees | 23 | — | 23 | 797 | ||||||||||||||
Total revenues | 10,359 | 17,323 | 31,065 | 55,260 | ||||||||||||||
Cost of revenues: | ||||||||||||||||||
Cost of product sales | 8,261 | 12,039 | 24,236 | 39,445 | ||||||||||||||
Inventory write-downs | — | 1,794 | 4,803 | 2,250 | ||||||||||||||
Total cost of revenues | 8,261 | 13,833 | 29,039 | 41,695 | ||||||||||||||
Gross profit | 2,098 | 3,490 | 2,026 | 13,565 | ||||||||||||||
Operating expenses: | ||||||||||||||||||
Research and development | 382 | 1,461 | 1,796 | 5,818 | ||||||||||||||
Sales and marketing | 1,004 | 2,794 | 3,910 | 7,098 | ||||||||||||||
General and administrative | 1,077 | 1,439 | 5,846 | 7,272 | ||||||||||||||
Amortization and depreciation | 372 | 8,108 | 3,195 | 24,460 | ||||||||||||||
Impairment of goodwill and other intangible assets | — | 42,003 | 2,729 | 42,003 | ||||||||||||||
Business restructuring charges | — | — | 841 | — | ||||||||||||||
Facility closing costs | — | 1,173 | — | 1,673 | ||||||||||||||
Total operating expenses | 2,835 | 57,978 | 18,317 | 88,324 | ||||||||||||||
Operating loss | (737 | ) | (54,488 | ) | (16,291 | ) | (74,759 | ) | ||||||||||
Gain (loss) on foreign exchange | 79 | (207 | ) | (471 | ) | 192 | ||||||||||||
Interest and other income (expense), net | (18 | ) | 410 | 5 | 704 | |||||||||||||
Net loss before income taxes | (676 | ) | (54,285 | ) | (16,757 | ) | (73,863 | ) | ||||||||||
Income tax benefit | 4 | 3,022 | 1,013 | 6,035 | ||||||||||||||
Net loss | $ | (672 | ) | $ | (51,263 | ) | $ | (15,744 | ) | $ | (67,828 | ) | ||||||
Loss per share — basic and diluted | $ | (0.04 | ) | $ | (2.91 | ) | $ | (0.89 | ) | $ | (3.88 | ) | ||||||
Weighted average shares used to compute loss per share — basic and diluted | 17,772 | 17,623 | 17,751 | 17,499 | ||||||||||||||
See accompanying notes to condensed consolidated financial statements.
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SMARTDISK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended | |||||||||||
September 30, | |||||||||||
2002 | 2001 | ||||||||||
(In thousands) | |||||||||||
(Unaudited) | |||||||||||
Cash flows from operating activities: | |||||||||||
Net loss | $ | (15,744 | ) | $ | (67,828 | ) | |||||
Adjustments to reconcile net loss to net cash used in operating activities: | |||||||||||
Amortization and depreciation | 3,195 | 24,460 | |||||||||
Impairment of goodwill and other intangible assets | 2,729 | 42,003 | |||||||||
Provision for uncollectible accounts, sales returns and other credits | 3,328 | 1,222 | |||||||||
Provision for inventory write-downs | 4,803 | 2,250 | |||||||||
Deferred income taxes | (791 | ) | (6,551 | ) | |||||||
Other | 520 | 203 | |||||||||
Changes in assets and liabilities: | |||||||||||
Accounts and notes receivable | (2,382 | ) | (1,553 | ) | |||||||
Inventories | (3,158 | ) | 5,554 | ||||||||
Prepaid expenses and other current assets | (824 | ) | 884 | ||||||||
Deposits and other assets | (29 | ) | 48 | ||||||||
Accounts payable | (300 | ) | (3,111 | ) | |||||||
Income taxes payable | (399 | ) | (240 | ) | |||||||
Deferred revenue | — | (725 | ) | ||||||||
Other accrued liabilities | (481 | ) | 913 | ||||||||
Net cash used in operating activities | (9,533 | ) | (2,471 | ) | |||||||
Cash flows from investing activities: | |||||||||||
Purchases of property and equipment, net of disposals | (59 | ) | (804 | ) | |||||||
Cash paid for intellectual property | — | (250 | ) | ||||||||
(Increase) decrease in restricted cash | (2,107 | ) | 1,671 | ||||||||
Purchases of short-term investments | — | (5,600 | ) | ||||||||
Sales and maturities of short-term investments | — | 6,007 | |||||||||
Net cash (used in) provided by investing activities | (2,166 | ) | 1,024 | ||||||||
Cash flows from financing activities: | |||||||||||
Net repayments under lines of credit | (76 | ) | (1,070 | ) | |||||||
Collections on notes receivable from officers/employees | 3 | 34 | |||||||||
Proceeds from exercise of stock options | 11 | 207 | |||||||||
Proceeds from stock issued under ESPP | 1 | 88 | |||||||||
Purchase of treasury stock | — | (5 | ) | ||||||||
Net cash used in financing activities | (61 | ) | (746 | ) | |||||||
Effect of exchange rate fluctuations on cash | 105 | (101 | ) | ||||||||
Decrease in cash and cash equivalents | (11,655 | ) | (2,294 | ) | |||||||
Cash and cash equivalents at beginning of period | 14,517 | 12,833 | |||||||||
Cash and cash equivalents at end of period | $ | 2,862 | $ | 10,539 | |||||||
See accompanying notes to condensed consolidated financial statements.
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SMARTDISK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. | Basis of Presentation |
The accompanying unaudited interim condensed consolidated financial statements for SmartDisk Corporation (“SmartDisk” or the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management, all adjustments, including normal recurring accruals, considered necessary for a fair presentation have been included. Certain amounts in prior periods condensed consolidated financial statements have been reclassified to conform to the current period presentation. The reclassifications had no effect on previously reported net loss or stockholders’ equity. Operating results for the three and nine-month periods ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002.
The Company has incurred net losses on a quarterly basis since the first quarter of 2000. The Company had cash and cash equivalents of approximately $14.5 million, $9.2 million, $4.4 million and $2.9 million as of December 31, 2001, March 31, 2002, June 30, 2002 and September 30, 2002, respectively. The Company has minimal financial resources, and its cash flow from operating activities continues to be insufficient to meet its operating needs and other payment obligations.
As part of the Company’s efforts to improve its liquidity and financial condition, during December 2002, the Company completed a private placement to the Chairman of its Board of Directors, and an entity controlled by its Chairman, who purchased from the Company an aggregate of 2,552,364.8 shares of the Company’s Series A Redeemable Convertible Preferred Stock for gross proceeds of approximately $2.5 million.
After giving effect to this investment and the implementation of the Company’s restructuring plan, and based on its current forecasted operations, the Company believes that its cash and cash equivalents and working capital will be sufficient to meet its operating requirements through December 31, 2003. However, the Company may be required to reduce its operations or to obtain additional financing if its forecast proves inaccurate for any reason, including the following: (i) the Company’s revenue fails to meet its forecast and continues to decline; (ii) the Company’s gross profit fails to meet its forecast and continues to erode; (iii) the Company’s operating expenses exceed its forecast; (iv) cash is required to collateralize letters of credit for issue to vendors or to prepay vendors for the supply of products or services; (v) cash flow from accounts receivable is reduced further or interrupted by slow collections or product returns; (vi) procurement of inventory exceeds market demand; (vii) purchase orders issued for the procurement of inventory in excess of market demand cannot be cancelled with the consequent negative impact on cash; (viii) vendors unilaterally change the payment terms under which they will supply product or services to the Company; or (ix) unanticipated events adversely effect the Company’s operations or cash flows. In addition, the Company’s continued viability beyond December 31, 2003 will depend upon its ability to generate cash from operations or to obtain additional working capital. Such additional capital, if required, may not be available to the Company or may be available on terms that may be unacceptable to the Company. These liquidity problems, amongst others, raise substantial doubt about the Company’s ability to continue as a going concern.
In the first quarter of 2002, the Company began the implementation of a restructuring plan in response to a decline in demand for its products and the competitive environment in which it operates. The restructuring plan included an involuntary reduction in workforce of 21 employees across all business functions and the curtailment of operating and other expenditures. The Company has filed a registration statement to raise
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additional capital through a rights offering. Once the registration statement is declared effective, the Company intends to distribute to its existing shareholders rights to purchase shares of the Company’s common stock. The Company intends to use the net proceeds from the rights offering for general working capital purposes and to improve its liquidity. The Company’s ability to continue as a going concern depends upon the success of its restructuring and cost containment measures and its ability to successfully complete the rights offering. These consolidated financial statements do not include any adjustments related to the recoverability of recorded asset amounts that might be necessary as a result of the above uncertainty.
The unaudited interim condensed consolidated financial statements should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in this report and the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2001, filed with the Securities and Exchange Commission. The balance sheet data as of December 31, 2001 was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States.
Note 2. | Restricted Cash |
Restricted cash as September 30, 2002 was composed of cash collateralized with the Company’s bankers to guarantee payment of the outstanding commercial and standby letters of credit.
Note 3. | Inventories |
Inventories are stated at the lower of cost or market (estimated net realizable value), with cost being determined on a first-in, first-out basis. Inventories consist of the following:
September 30, | ||||
2002 | ||||
(In thousands) | ||||
Finished goods | $ | 5,523 | ||
Raw materials | 1,164 | |||
Total inventories | $ | 6,687 | ||
Note 4. | Net Loss Per Share |
For the three months ended September 30, 2002 and 2001, potential common shares totaling 6,300 and 193,596, respectively, were excluded from the computation of net loss per share because their effect was anti-dilutive. For the nine months ended September 30, 2002 and 2001, potential common shares totaling 118,502 and 289,908, respectively, were excluded from the computation of net loss per share because their effect was anti-dilutive. Potential common shares include stock options and shares of non-vested stock.
Note 5. | Comprehensive Loss |
Other comprehensive income (loss) refers to revenues, expenses, gains, and losses that under accounting principles generally accepted in the United States are included in comprehensive loss but are excluded from net loss as these amounts are recorded directly as an adjustment to stockholders’ equity, net of tax. SmartDisk’s other comprehensive income (loss) is composed of unrealized gains and losses on available-for-
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sale securities and foreign currency translation adjustments. The following table sets forth the computation of comprehensive loss for the periods indicated:
Three Months Ended | Nine Months Ended | ||||||||||||||||
September 30, | September 30, | ||||||||||||||||
2002 | 2001 | 2002 | 2001 | ||||||||||||||
(In thousands) | |||||||||||||||||
Net loss | $ | (672 | ) | $ | (51,263 | ) | $ | (15,744 | ) | $ | (67,828 | ) | |||||
Other comprehensive income (loss): | |||||||||||||||||
Unrealized loss on short-term investments, net of tax | — | (4 | ) | — | (6 | ) | |||||||||||
Foreign currency translation adjustment | (233 | ) | 303 | 582 | (220 | ) | |||||||||||
Total comprehensive loss | $ | (905 | ) | $ | (50,964 | ) | $ | (15,162 | ) | $ | (68,054 | ) | |||||
Note 6. | Business Restructuring |
In the first quarter of 2002, the Company began the implementation of a restructuring plan in response to a decline in demand for its products and the competitive environment in which it operates and recorded a restructuring charge of $0.841 million. The restructuring plan included an involuntary reduction in workforce of 21 employees across all business functions and the curtailment of certain expenditures, such as advertising, marketing, tradeshows, contract labor and consulting services, recruiting and traveling. Through September 30, 2002, a total of 33 employees have been terminated, which represents an additional 12 employees over and above the restructuring plan total. As of September 30, 2002, employee separation payments amounted to $0.336 million.
The elements of the restructuring costs related to the restructuring plan are as follows:
Restructuring | ||||||||||||||||
Liability at | ||||||||||||||||
Total | Non-cash | Cash | June 30, | |||||||||||||
Charge | Charges | Payments | 2002 | |||||||||||||
(In thousands) | ||||||||||||||||
Workforce reduction | $ | 513 | $ | — | $ | (336 | ) | $ | 177 | |||||||
Facility lease and contract settlement costs | 96 | (46 | ) | — | 50 | |||||||||||
Write-down of property and equipment, net | 232 | (232 | ) | — | — | |||||||||||
Total | $ | 841 | $ | (278 | ) | $ | (336 | ) | $ | 227 | ||||||
Note 7. | Impairment of Goodwill and Other Intangible Assets |
The Company continually evaluates the recoverability of its goodwill in accordance with Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 142,Goodwill and Other Intangible Assets. In addition, the Company continually evaluates the recoverability of its other intangible assets in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets.
Under SFAS No. 142, goodwill of a reporting unit is tested for impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Examples of such events or circumstances include, but are not limited to a significant adverse change in legal factors or in the business climate, unanticipated competition and a more-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Under SFAS No. 142, goodwill is tested for impairment at a level of reporting referred to as a reporting unit. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. A two-step impairment test is used to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized.
The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any.
The second step of the goodwill impairment test, used to measure the amount of impairment loss, compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.
The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in connection with a business combination is determined. That is, the fair value of a reporting unit is allocated to all assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the price paid to acquire the reporting unit. The excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities is the implied fair value of goodwill.
Under SFAS No. 144, an impairment review is performed if events occur or circumstances change indicating that the carrying amount might not be recoverable. Factors considered important which could trigger an impairment review include, but are not limited to, a significant decrease in the market value, a significant adverse change in legal factors or in the business climate, a current period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses and a current expectation that more-likely-than-not a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. If any of the impairment indicators are present or if other circumstances indicate that an impairment may exist, the Company must then determine whether an impairment loss should be recognized. An impairment loss can only be recognized if the undiscounted cash flows used to test for recoverability are less than the carrying value. If the Company determines that an impairment loss should be recognized, the impairment measured is based on the difference between the fair value and the carrying value.
As a result of the significant decline in the operating results and cash flows of personal storage products and European operations, combined with marginal historical operating and cash flow results, the Company undertook its impairment reviews. Based on impairment reviews performed at March 31, 2002, in relation to the carrying values of goodwill and other intangible assets recorded in connection with the acquisitions of VST Technologies, Inc. and Impleo Limited, as well as a license obtained from SanDisk Corporation to sell FlashPath for the MultiMediaCard, a $2.729 million impairment charge was provided in the quarter ended March 31, 2002 to reduce the carrying value of the aforementioned assets to zero. The fair values used in measuring the impairment charge was determined based upon estimated discounted future cash flows. The assumptions supporting future cash flows, including the discount rate, were determined using the Company’s best estimates.
The changes in the carrying amount of goodwill for the nine months ended September 30, 2002 are as follows, in thousands:
Balance as of December 31, 2001 | $ | 2,482 | ||
Impairment loss | (2,482 | ) | ||
Balance as of September 30, 2002 | $ | — | ||
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The carrying amount of other intangible assets subject to amortization consist of the following:
September 30, | December 31, | |||||||||||
Life | 2002 | 2001 | ||||||||||
(In thousands) | ||||||||||||
Patents | 2-3 yrs. | $ | 8,119 | $ | 10,149 | |||||||
Distribution channels | 2 yrs. | — | 200 | |||||||||
Trade names | 1-2 yrs. | — | 150 | |||||||||
Covenants not-to-compete | 2 yrs. | — | 21,450 | |||||||||
Licenses | 10 yrs. | 240 | 540 | |||||||||
Total other intangible assets | 8,359 | 32,489 | ||||||||||
Accumulated amortization | (8,203 | ) | (29,627 | ) | ||||||||
Other intangible assets, net | $ | 156 | $ | 2,862 | ||||||||
Note 8. | Segment Information |
During the first quarter of 2002, SmartDisk began reporting its operations as one business segment. Previously, the Company had reported two business segments: personal storage and digital connectivity. Discrete financial information was previously available and reviewed by management to assess operating performance and make decisions regarding the allocation of resources to these segments. The change to a singular business segment was effected to conform to organizational changes made in the management of the Company’s business to more effectively report on the deployment and utilization of its assets. The organizational changes leading to the change in reporting included the closing of the Acton, Massachusetts, facility, which allowed the Company to consolidate previously independent but redundant operations and unify various functions and processes, including, but not limited to sales, marketing, customer and technical support, finance and product development; thereby, allowing the singular presentation of the Company in the marketplace where previously the Company was represented by two distinct companies, SmartDisk Corporation and VST Technologies, Inc. As a result, the previous separation, deployment and utilization of assets no longer occurs. Furthermore, the Company’s management neither evaluates the Company using the previously reported segments nor separately allocates resources to the aforementioned segments.
Note 9. | Facility Closing |
On May 31, 2001, the Company announced its intention to close its Acton, Massachusetts facility and move those operations into its Naples, Florida headquarters. In connection with the closing, which was substantially completed as of September 30, 2001, the Company recognized $1.173 million and $1.673 million in expenses during the three and nine months ended September 30, 2001, respectively. Total facility closing expenses comprised of $0.644 million in severance costs, $0.530 million in lease cancellation costs and $0.499 in property and equipment write-downs. The severance costs incurred in association with the closing of the facility related to 20 employees whose positions were eliminated.
Note 10. | Contingencies |
The Company relies on a combination of patents, trademarks, copyright and trade secret laws, confidentiality procedures and licensing arrangements to protect its intellectual property rights. There can be no assurance that there will not be any disputes regarding the Company’s intellectual property rights. Specifically, there can be no assurance that any patents held by the Company will not be invalidated, that patents will be issued for any of the Company’s pending applications or that any claims allowed from existing or pending patents will be of sufficient scope or strength or be issued in the primary countries where the
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Company’s products can be sold that will provide meaningful protection or any commercial advantage to the Company. Additionally, competitors of the Company may be able to design around the Company’s patents.
On June 26, 2000, a party filed a complaint in the Central District Federal Court of the State of California alleging SmartDisk’s infringement of a patent. The plaintiff contends that the Company’s floppy disk adapters, “FlashPath” and “Smarty” (which are no longer made by the Company) infringe the plaintiff’s patent. The Company began to sell the FlashPath products during April 1998 and continues to sell those products currently. The Company sold Smarty products beginning in April 1998. Plaintiff’s complaint seeks an undisclosed amount of damages, an injunction, and recall as well as attorneys’ fees. The plaintiff’s patent relates to a computer with a floppy diskette drive coupler that is shaped like a floppy disk and that couples to and from an external end user computer peripheral device having an input/output port “normally connectable” or “traditionally connectable” to a “conventional” or “standard” computer input/output port. The Company believes that PC Connector Solutions amended its patent application claims to add the quoted limiting language after it was unsuccessful in persuading the U.S. Patent and Trademark Office to approve broader claims. The Company does not believe that it uses the claimed technology since its products do not provide the claimed coupling to an external peripheral device, nor to any peripheral device that was normally or traditionally connectable to a conventional or standard computer input/output port as of the October 1988 filing date of the plaintiff’s patent. The Company does not believe that the flash memory and smart card modules that its FlashPath and former Smarty products couple to a computer are end user peripheral devices that were “normally” or “traditionally” connectable to a “conventional” or “standard” computer input/output port on the back of a computer. On November 20, 2000, the Company prevailed in moving the venue for such action from the State of California to the Middle District of Florida. During November 2001, prior to any discovery in the litigation, the court granted a Joint Motion to Stay the litigation pending a Request for Reexamination by the U.S. Patent and Trademark Office filed by the patent owner, which has since been lifted. In a November 2002 Reexamination Certificate, the U.S. Patent and Trademark Office confirmed the patentability of all patent claims. Based on the discussion above, and for other reasons, the Company considers this claim to be wholly without merit and will vigorously defend against such claim. Accordingly, the ultimate loss, if any, that may result cannot be reasonably determined and, accordingly, no accrual for this matter has been recorded as of December 31, 2001.
On July 26, 2001, a securities class action suit was filed against SmartDisk, the following executive officers and directors: Addison M. Fischer, Michael S. Battaglia and Michael R. Mattingly, and the following underwriters of SmartDisk’s initial public offering: FleetBoston Robertson Stephens, Inc. (formerly BancBoston Robertson Stephens, Inc.), Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. The suit was filed in the United States District Court for the Southern District of New York on behalf of all persons who acquired SmartDisk securities between October 6, 1999 and December 6, 2000. The complaint charges defendants with violations of Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 (and Rule 10b-5 promulgated thereunder), for issuing a Registration Statement and Prospectus (“Prospectus”) that contained material misrepresentations and/or omissions. The complaint alleges that the Prospectus was false and misleading because it failed to disclose (i) the agreements between FleetBoston Robertson Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain investors to provide them with significant amounts of restricted SmartDisk shares in the initial public offering (“IPO”) in exchange for excessive and undisclosed commissions; and (ii) the agreements between FleetBoston Robertson Stephens, Inc., Hambrecht & Quist LLC, and U.S. Bancorp Piper Jaffray, Inc. and certain customers under which the underwriters would allocate shares in the IPO to those customers in exchange for the customers’ agreement to purchase SmartDisk shares in the after-market at pre-determined prices. The complaint seeks an undisclosed amount of damages, as well as attorney fees. This lawsuit is in one of the more than 300 class actions that have been filed against various underwriters, issuers and individuals in the United States District Court for the Southern District of New York. These cases have been consolidated and SmartDisk, together with all or substantially all of the underwriters, issuers and individual defendants in
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
these consolidated class actions, have moved to dismiss all of the consolidated amended complaints, including that directed against SmartDisk, as legally insufficient. All discovery in these consolidated actions has been stayed pending determination of the motions to dismiss. Pursuant to the terms of a tolling agreement, the action has been dismissed without prejudice against each of the individual defendants named in the suit. Because these claims involve alleged secret agreements between underwriters and their investors and customers that were unknown to the Company and because of other legal inadequacies in the plaintiff’s allegations, SmartDisk considers this claim, as it relates to SmartDisk, to be wholly without merit and will vigorously defend against such claim. Accordingly, the ultimate loss, if any, that may result cannot be reasonably determined and, accordingly, no accrual for this matter has been recorded as of September 30, 2002.
On November 30, 2001, a complaint was filed in the Southern District of New York by Dynacore Holdings Corporation and Dynacore Patent Litigation Trust alleging SmartDisk’s infringement of said parties’ patent relating to local area network (“LAN”) capabilities. The complaint seeks an undisclosed amount of damages, injunction and recall, as well as attorney fees. SmartDisk has signed a Joint Defense Agreement with the other defendants, and the defendants have filed a dispositive Motion for Summary Judgment. SmartDisk considers this claim, as it relates to SmartDisk, to be wholly without merit and will vigorously defend against such claim. Accordingly, the ultimate loss, if any, that may result cannot be reasonably determined and, accordingly, no accrual for this matter has been recorded as of September 30, 2002.
On May 6, 2002, SmartDisk received a demand from the trustee in the bankruptcy proceeding of MicroAge, Inc., a former customer of the Company’s subsidiary, VST Technologies, Inc. (“VST”), for recovery of approximately $0.505 million that MicroAge, Inc. had paid to VST over the period from January 15, 2000 to April 13, 2000, inclusive. SmartDisk disputes the amount demanded and intends to defend against the demand.
On June 13, 2002, SmartDisk received a letter from counsel to SoftRAID LLC, a former supplier to VST, demanding payment of $0.285 million pursuant to a Software License Agreement with SmartDisk. On July 31, 2002, SoftRAID notified SmartDisk of its intention to arbitrate the dispute pursuant to the arbitration provisions of the Software License Agreement, and the American Arbitration Association commenced administration of this proceeding. Prior to the case being presented before the American Bar Association, the parties reached an agreement on the disputed matter. The cost of the settlement was not material to the Company.
Note 11. | Recent Accounting Pronouncements |
Effective January 1, 2002, the Company adopted SFAS No. 141,Business Combinations. SFAS No. 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting and broadens the criteria for recording intangible assets apart from goodwill. The Company evaluated its goodwill and other intangibles acquired prior to June 30, 2001 using the SFAS No. 141 criteria. This evaluation did not result in any reclassification between other intangible assets and goodwill at January 1, 2002. The adoption of SFAS No. 141 did not have a material impact on the Company’s financial position, results of operations or cash flows, but it will impact the accounting treatment of future acquisitions.
Effective January 1, 2002, the Company adopted SFAS No. 142,Goodwill and Other Intangible Assets. SFAS No. 142 requires that purchased goodwill and certain indefinite-lived intangibles no longer be amortized, but instead be tested for impairment at least annually, or more frequently as impairment indicators arise, in accordance with SFAS No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The Company evaluated its intangible assets and believes that all such assets have determinable lives.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
In accordance with SFAS No. 142, the effect of the accounting change for goodwill amortization is reflected prospectively. Supplemental comparative disclosure as if the change had been retroactively applied to the prior year period is as follows:
Three Months Ended | Nine Months Ended | |||||||||||||||||
September 30, | September 30, | |||||||||||||||||
2002 | 2001 | 2002 | 2001 | |||||||||||||||
(In thousands, except per share amounts) | ||||||||||||||||||
Net loss: | ||||||||||||||||||
Reported net loss | $ | (672 | ) | $ | (51,263 | ) | $ | (15,744 | ) | $ | (67,828 | ) | ||||||
Goodwill amortization | — | 2,427 | — | 7,279 | ||||||||||||||
Adjusted net loss | $ | (672 | ) | $ | (48,836 | ) | $ | (15,744 | ) | $ | (60,549 | ) | ||||||
Loss per share — basic and diluted: | ||||||||||||||||||
Reported loss per share | $ | (0.04 | ) | $ | (2.91 | ) | $ | (0.89 | ) | $ | (3.88 | ) | ||||||
Goodwill amortization | — | 0.14 | — | 0.42 | ||||||||||||||
Adjusted loss per share | $ | (0.04 | ) | $ | (2.77 | ) | $ | (0.89 | ) | $ | (3.46 | ) | ||||||
Shares used in per share computation | 17,772 | 17,623 | 17,751 | 17,499 | ||||||||||||||
See Note 7 for further discussion regarding the impact of SFAS No. 142 and related impairment charge.
Effective January 1, 2002, the Company adopted SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. SFAS No. 144 applies to all long-lived assets (including discontinued operations) and consequently amends APB Opinion No. 30,Reporting the Results of Operations, Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS No. 144 develops one accounting model for long-lived assets that are to be disposed of by sale. SFAS No. 144 requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. The adoption of SFAS No. 144 did not have a material impact on the Company’s financial position, results of operations or cash flows. See Note 7 for further discussion regarding the impact of SFAS No. 144 and related impairment charge.
In April 2002, the FASB issued SFAS No. 145,Rescission of FASB Statements Nos. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 eliminates SFAS No. 4,Reporting Gains and Losses from Extinguishment of Debt, (and SFAS No. 64,Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements, as it amends SFAS No. 4), which requires gains and losses from extinguishments of debt to be aggregated and, if material, classified as an extraordinary item, net of the related income tax effect. As a result, the criteria in Accounting Principles Board (“APB”) Opinion No. 30 will now be used to classify those gains and losses. SFAS No. 145 amends SFAS No. 13,Accounting for Leases, to require that certain lease modifications that have economic effects similar to sale-leaseback transactions are accounted for in the same manner as sale-leaseback transactions. This amendment is consistent with the FASB’s goal of requiring similar accounting treatment for transactions that have similar economic effects. In addition, SFAS No. 145 makes technical corrections to existing pronouncements. While those corrections are not substantive in nature, in some instances, they may change accounting practice. This statement is effective for fiscal years beginning after May 2002 for the provisions related to the rescission of SFAS Nos. 4 and 64, and for all transactions entered into beginning May 2002 for the provision related to the amendment of SFAS
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No. 13 although early adoption is permitted. The adoption of SFAS No. 145 did not have a material impact on the Company’s financial condition, results of operations or cash flows.
In June 2002, the FASB issued SFAS No. 146,Accounting for Exit or Disposal Activities, effective for exit or disposal activities that are initiated after December 31, 2002, with early adoption encouraged. SFAS No. 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for pursuant to the guidance that the Emerging Issues Task Force (“EITF”) has set forth in EITF Issue No. 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs incurred in a Restructuring). A fundamental conclusion reached by the FASB in this Statement is that an entity’s commitment to a plan, by itself, does not create a present obligation to others that meets the definition of a liability. Therefore, this SFAS eliminates the definition and requirements for recognition of exit costs in EITF Issue No. 94-3. This statement also establishes that fair value is the objective for initial measurement of the liability. The scope of SFAS No. 146 also includes (1) costs related to terminating a contract that is not a capital lease and (2) termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement or an individual deferred-compensation contract. The Company does not expect the implementation of this standard to have a material impact on the Company’s financial condition, results of operations or cash flows.
Note 12. Subsequent Event
On December 24, 2002, Addison Fischer, Chairman of the Company’s Board of Directors, and Phoenix House Investments, LP, an entity controlled by Mr. Fischer, purchased from the Company an aggregate of 2,552,364.8 shares of the Company’s Series A Redeemable Convertible Preferred Stock for gross proceeds of approximately $2.5 million. Each share of Series A Preferred is convertible into shares of common stock at an initial conversion price of $0.32 per share of common stock such that each share of Series A Preferred is initially convertible into 3.125 shares of common stock.
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You may rely on the information contained in this prospectus. We have not authorized anyone to provide information different from that contained in this prospectus. Neither the delivery of this prospectus nor the sale of common stock means that information contained in this prospectus is correct after the date of this prospectus. This prospectus is not an offer to sell or a solicitation of an offer to buy these shares of common stock in any jurisdictions in which the offer or solicitation is unlawful.
Page | ||||
Summary | 1 | |||
Risk Factors | 8 | |||
Forward-Looking Statements | 23 | |||
Use of Proceeds | 23 | |||
Price Range of Common Stock | 25 | |||
Capitalization | 26 | |||
Selected Consolidated Financial Data | 27 | |||
Management’s Discussion and Analysis of Financial Condition and Results of Operations | 28 | |||
Business | 46 | |||
Management | 56 | |||
Certain Relationships and Related Transactions | 63 | |||
Principal Stockholders | 66 | |||
The Rights Offering | 68 | |||
Material United States Federal Income Tax Considerations | 79 | |||
Description of Securities | 80 | |||
Plan of Distribution | 84 | |||
Legal Matters | 84 | |||
Experts | 84 | |||
Where You Can Obtain Additional Information | 84 | |||
If You Have Questions | 85 | |||
Index to Consolidated Financial Statements | F-1 |
22,238,463 Shares
Common Stock
PROSPECTUS
, 2003
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PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. | Other Expenses of Issuance and Distribution. |
The following table sets forth the expenses payable by the Registrant in connection with the offering described in the Registration Statement. All of the amounts shown are estimates except for the registration fee:
Amount to be Paid | ||||
Registration Fee | $ | 690 | ||
Subscription Agent Fees and Expenses | $ | 35,000 | ||
Blue Sky Fees and Expenses | $ | 10,000 | ||
Legal Fees and Expenses | $ | 75,000 | ||
Financial Advisor Fees | $ | 50,000 | ||
Accountants’ Fees and Expenses | $ | 120,000 | ||
Printing and Engraving Expenses | $ | 50,000 | ||
Miscellaneous Fees and Expenses | $ | 19,310 | ||
Total | $ | 350,000 | ||
Item 14. | Indemnification of Directors and Officers. |
Section 145 of the Delaware General Corporation Law authorizes a court to award or a corporation’s board of directors to grant indemnification to directors and officers in terms sufficiently broad to permit such indemnification under certain circumstances for liabilities (including reimbursement for expenses incurred) arising under the Securities Act. Our bylaws provide for mandatory indemnification of our directors and officers and permissible indemnification of employees and other agents to the maximum extent permitted by the Delaware General Corporation Law. Our certificate of incorporation provides that, pursuant to Delaware law, our directors shall not be liable for monetary damages for breach of the directors’ fiduciary duty as directors to us and our stockholders. This provision in the certificate of incorporation does not eliminate the directors’ fiduciary duty, and in appropriate circumstances equitable remedies such as injunctive or other forms of non-monetary relief will remain available under Delaware law. In addition, each director will continue to be subject to liability for breach of the director’s duty of loyalty to us for acts or omissions not in good faith or involving intentional misconduct, for knowing violations of law, for actions leading to improper personal benefit to the director, and for payment of dividends or approval of stock repurchases or redemptions that are unlawful under Delaware law. The provision also does not affect a director’s responsibilities under any other law, such as the federal securities laws or state or federal environmental laws. In addition, we have entered into Indemnification Agreements with our officers and directors. The Indemnification Agreements provide our officers and directors with further indemnification to the maximum extent permitted by the Delaware General Corporation Law.
Item 15. | Recent Sales of Unregistered Securities. |
On March 6, 2000, we issued to 14 former stockholders of VST Technologies, Inc., a Delaware corporation, 1,073,490 shares of our common stock at a deemed value of $32.50 per share in connection with our acquisition of VST. We issued these shares under the Securities Act in reliance on the exemption provided by Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.
On April 28, 2000, we issued to 16 former owners of Impleo Limited, a corporation established under the laws of the United Kingdom, 125,051 shares of our common stock at a deemed value of $26.98 per share in connection with our acquisition of Impleo. We issued these shares under the Securities Act in reliance on the
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During March 2001, we issued to Rod H. King, our former Senior Vice President, Sales and Marketing, 6,000 shares of common stock at a deemed value of $3.00 per share as a portion of a signing bonus for joining our company. We issued these shares without registration under the Securities Act in reliance on the exemption provided by Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.
During April 2002, we issued to Peter J. Quinn, our Chief Financial Officer, 15,625 shares of common stock at a deemed value of $1.60 per share as a portion of a signing bonus for joining our company. We issued these shares without registration under the Securities Act in reliance on the exemption provided by Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.
On December 24, 2002, Addison Fischer, Chairman of our Board of Directors, and Phoenix House Investments, LP, an entity controlled by Mr. Fischer, purchased from us an aggregate of 2,552,364.8 shares of our Series A Redeemable Convertible Preferred Stock at a purchase price of $1.00 per share, for gross proceeds of approximately $2.5 million. Each share of Series A Preferred is convertible into shares of common stock at an initial conversion price of $0.32 per share of common stock such that each share of Series A Preferred is initially convertible into 3.125 shares of common stock. However, in no event may the aggregate number of shares of common stock issuable upon conversion of all shares of Series A Preferred exceed 3,556,777 shares unless
• | our stockholders approve the issuance of all shares of common stock issuable upon conversion of the Series A Preferred at a meeting duly called for such purpose; | |
• | we obtain permission from NASDAQ to allow such issuance without any limitation on the number of shares of common stock issuable upon conversion of the shares of Series A Preferred; or | |
• | we are no longer governed by a rule promulgated by a stock exchange, NASDAQ, or other applicable body prohibiting the issuance of common stock upon conversion of the Series A Preferred in excess of 19.9% of the number of shares of common stock outstanding without stockholder approval. | |
Immediately upon the satisfaction of any of the conditions listed above, all outstanding shares of Series A Preferred will be converted automatically into the number of shares of common stock into which the shares of Series A Preferred are then convertible as of the date of the satisfaction of such condition. We have agreed with the holders of Series A Preferred that without the consent of a majority in interest of the holders of Series A Preferred, we will not hold a special meeting of stockholders or otherwise seek stockholder approval that would result in mandatory conversion of the common stock. We issued these shares without registration under the Securities Act in reliance on the exemption provided by Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.
Item 16. | Exhibits and Financial Statement Schedules. |
Exhibit | ||||
Number | Description | |||
3 | .1 | Restated Certificate of Incorporation (3.1)(1) | ||
3 | .2 | Certificate of Designations of Series A Redeemable Convertible Preferred Stock of SmartDisk (3.2)(10) | ||
3 | .3 | Bylaws (3.2)(1) | ||
4 | .1 | Specimen Common Stock Certificate | ||
4 | .2 | Form of Subscription Certificate | ||
5 | .1 | Form of Legal Opinion of Greenberg Traurig, LLP | ||
8 | .1 | Form of Tax Opinion of Greenberg Training, LLP | ||
10 | .1 | 1998 Employee Stock Option Plan (10.1)(1)* | ||
10 | .2 | 1998 Directors and Consultants Stock Option Plan (10.2)(1)* |
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Exhibit | ||||
Number | Description | |||
10 | .3 | 1999 Incentive Compensation Plan (10.3)(5)* | ||
10 | .4 | 1999 Employee Stock Option Plan (10.4)(1)* | ||
10 | .5 | Employment Agreement with Rod H. King (10.27)(6) | ||
10 | .6 | Employment Agreement with Quresh Sachee (10.6)(7) | ||
10 | .7 | Services Agreement dated October 12, 2001 between IM-Logistics, a division of Ingram, Inc. and SmartDisk (10.7)(7) | ||
10 | .8 | License Agreement dated May 26, 1998 between Toshiba Corporation and SmartDisk, as amended (10.8)(1) | ||
10 | .9 | Investors’ Rights Agreement dated May 22, 1998 among SmartDisk and each of the investors a party thereto (10.12)(1) | ||
10 | .10 | Amendment Number One to Investors’ Rights Agreement dated July 1999 among SmartDisk and each of the investors a party thereto (10.13)(3) | ||
10 | .11 | Lease Agreement dated October 4, 1993 between Arnold Industrial Park and SmartDisk, by Assignment (10.13)(1) | ||
10 | .12 | Lease Agreement dated October 4, 1993 between Arnold Industrial Park and SmartDisk, by Assignment (10.12)(7) | ||
10 | .13 | Development and License Agreement dated June 30, 1999 between SmartDisk and Sony Corporation (10.19)(8) | ||
10 | .14 | Development and License Agreement dated December 1, 1999 between SmartDisk and Sony Corporation (10.16)(3) | ||
10 | .15 | Cooperative Development Agreement dated June 30, 1999 between SmartDisk and SanDisk Corporation (10.15)(1) | ||
10 | .16 | Form of Indemnification between the Registrant and each of its directors and executive officers (10.16)(1) | ||
10 | .17 | Joint Venture Agreement dated as of February 24, 1998 by and among Phoenix House Investments, L.L.C., Toshiba Corporation and SmartDisk (10.17)(1) | ||
10 | .18 | Amendment No. 2 to License Agreement dated April 1, 1999 between Toshiba Corporation and SmartDisk (10.20)(4) | ||
10 | .19 | Employment Agreement with Michael S. Battaglia (10.1)(9) | ||
10 | .20 | Employment Agreement with Peter J. Quinn (10.2)(9) | ||
10 | .21 | Series A Redeemable Convertible Preferred Stock Purchase Agreement dated December 9, 2002 among SmartDisk and the Investors named therein (10.21)(10) | ||
10 | .22 | First Amendment to Series A Redeemable Convertible Preferred Stock Purchase Agreement dated December 24, 2002 among SmartDisk and the Investors named therein (10.22)(10) | ||
10 | .23 | Registration Rights Agreement dated December 24, 2002 among SmartDisk and the Investors named therein (10.23)(10) | ||
10 | .24 | Lease Agreement dated December 17, 2002 between SmartDisk and Baader North American Corporation (Fort Myers Facility) | ||
21 | .1 | Subsidiaries of SmartDisk (21.1)(7) | ||
23 | .1 | Consent of Ernst & Young LLP, Independent Certified Public Accountants | ||
23 | .2 | Consent of Greenberg Traurig, LLP (included in Exhibits 5.1 and 8.1) | ||
24 | .0 | Power of Attorney of Directors and Executive Officers (included on Signature Page)** | ||
99 | .1 | Instructions on Use of SmartDisk Corporation Subscription Certificates | ||
99 | .2 | Notice of Guaranteed Delivery | ||
99 | .3 | Form of Letter to Stockholders | ||
99 | .4 | Form of Letter to Brokers | ||
99 | .5 | Form of Letter from Brokers or Other Nominees to Beneficial Owners |
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Exhibit | ||||
Number | Description | |||
99 | .6 | Instructions by Beneficial Owners to Brokers or Other Nominees | ||
99 | .7 | Form of Subscription Agent Agreement between SmartDisk and American Stock Transfer & Trust Company |
(1) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s registration statement on Form S-1 (Registration No. 333-82793). |
(2) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Current Report on Form 8-K on March 21, 2000 (File No. 000-27257). |
(3) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 000-27257). |
(4) | Incorporated by reference to the exhibit in the preceding parentheses as filed with Amendment No. 1 to SmartDisk’s Annual Report on Form 10-K/A for the year ended December 31, 1999 (File No. 000-27257). |
(5) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000 (File No. 000-27257). |
(6) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 (File No. 000-27257). |
(7) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Annual Report on Form 10-K for the year ended December 31, 2001 (File No. 000-27257). |
(8) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 000-27257). |
(9) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File No. 000-27257). |
(10) | Incorporated by reference to the exhibit in the preceding parenthesis as filed with SmartDisk’s Current Report on Form 8-K dated December 24, 2002. |
* | Management Compensation Plan or Arrangement. |
** | Previously filed. |
† | Certain information in these exhibits has been omitted pursuant to a request for confidential treatment filed with the SEC. |
Item 17. | Undertakings. |
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a post-effective amendment to this Registration Statement: |
(i) To include any prospectus required by Section 10(a)(3) of the Securities Act of 1933; | |
(ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the SEC pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than a 20% change in the maximum aggregate offering price set forth in the “Calculation of Registration Fee” table in the effective registration statement. |
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(iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement; |
(2) That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. | |
(3) To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering. |
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. | |
(2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. |
The undersigned Registrant hereby undertakes to supplement the prospectus, after the expiration of the subscription period, to set forth the results of the subscription offer, the transactions during the subscription period, the amount of unsubscribed securities to be purchased, and the terms of any subsequent reoffering thereof. If any public offering is to be made on terms differing from those set forth on the cover page of the prospectus, a post-effective amendment will be filed to set forth the terms of such offering.
Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers, and controlling persons of the Registrant pursuant to the provisions or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer, or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Naples, state of Florida, on the 31st day of January, 2003.
SMARTDISK CORPORATION |
By: | /s/ MICHAEL S. BATTAGLIA |
Michael S. Battaglia | |
President and Chief Executive Officer |
Pursuant to the requirements of the Securities Act of 1933, this registration statement has been signed by the following persons in the capacities and on the dates indicated.
Name | Title | Date | ||||
* Addison Fischer | Chairman of the Board of Directors | January 31, 2003 | ||||
/s/ MICHAEL S. BATTAGLIA Michael S. Battaglia | President, Chief Executive Officer and Director (Principal Executive Officer) | January 31, 2003 | ||||
/s/ PETER J. QUINN Peter J. Quinn | Chief Financial Officer (Principal Financial and Accounting Officer) | January 31, 2003 | ||||
* Anthony A. Ibargüen | Director | January 31, 2003 | ||||
* Emmanuel A. Kampouris | Director | January 31, 2003 | ||||
Kiyoshi Kobayashi | Director | January 31, 2003 | ||||
* Timothy Tomlinson | Director | January 31, 2003 | ||||
*By: /s/ MICHAEL S. BATTAGLIA Michael S. Battaglia Attorney-in-Fact |
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EXHIBIT INDEX
Exhibit | ||||
Number | Description | |||
3 | .1 | Restated Certificate of Incorporation (3.1)(1) | ||
3 | .2 | Certificate of Designations of Series A Redeemable Convertible Preferred Stock of SmartDisk (3.2)(10) | ||
3 | .3 | Bylaws (3.2)(1) | ||
4 | .1 | Specimen Common Stock Certificate | ||
4 | .2 | Form of Subscription Certificate | ||
5 | .1 | Form of Legal Opinion of Greenberg Traurig, LLP | ||
8 | .1 | Form of Tax Opinion of Greenberg Traurig, LLP | ||
10 | .1 | 1998 Employee Stock Option Plan (10.1)(1)* | ||
10 | .2 | 1998 Directors and Consultants Stock Option Plan (10.2)(1)* | ||
10 | .3 | 1999 Incentive Compensation Plan (10.3)(5)* | ||
10 | .4 | 1999 Employee Stock Option Plan (10.4)(1)* | ||
10 | .5 | Employment Agreement with Rod H. King (10.27)(6) | ||
10 | .6 | Employment Agreement with Quresh Sachee (10.6)(7) | ||
10 | .7 | Services Agreement dated October 12, 2001 between IM-Logistics, a division of Ingram, Inc. and SmartDisk (10.7)(7) | ||
10 | .8 | License Agreement dated May 26, 1998 between Toshiba Corporation and SmartDisk, as amended (10.8)(1) | ||
10 | .9 | Investors’ Rights Agreement dated May 22, 1998 among SmartDisk and each of the investors a party thereto (10.12)(1) | ||
10 | .10 | Amendment Number One to Investors’ Rights Agreement dated July 1999 among SmartDisk and each of the investors a party thereto (10.13)(3) | ||
10 | .11 | Lease Agreement dated October 4, 1993 between Arnold Industrial Park and SmartDisk, by Assignment (10.13)(1) | ||
10 | .12 | Lease Agreement dated October 4, 1993 between Arnold Industrial Park and SmartDisk, by Assignment (10.12)(7) | ||
10 | .13 | Development and License Agreement dated June 30, 1999 between SmartDisk and Sony Corporation (10.19)(8) | ||
10 | .14 | Development and License Agreement dated December 1, 1999 between SmartDisk and Sony Corporation (10.16)(3) | ||
10 | .15 | Cooperative Development Agreement dated June 30, 1999 between SmartDisk and SanDisk Corporation (10.15)(1) | ||
10 | .16 | Form of Indemnification between the Registrant and each of its directors and executive officers (10.16)(1) | ||
10 | .17 | Joint Venture Agreement dated as of February 24, 1998 by and among Phoenix House Investments, L.L.C., Toshiba Corporation and SmartDisk (10.17)(1) | ||
10 | .18 | Amendment No. 2 to License Agreement dated April 1, 1999 between Toshiba Corporation and SmartDisk (10.20)(4) | ||
10 | .19 | Employment Agreement with Michael S. Battaglia (10.1)(9) | ||
10 | .20 | Employment Agreement with Peter J. Quinn (10.2)(9) | ||
10 | .21 | Series A Redeemable Convertible Preferred Stock Purchase Agreement dated December 9, 2002 among SmartDisk and the Investors named therein (10.21)(10) | ||
10 | .22 | First Amendment to Series A Redeemable Convertible Preferred Stock Purchase Agreement dated December 24, 2002 among SmartDisk and the Investors named therein (10.22)(10) | ||
10 | .23 | Registration Rights Agreement dated December 24, 2002 among SmartDisk and the Investors named therein (10.23)(10) |
Table of Contents
Exhibit | ||||
Number | Description | |||
10 | .24 | Lease Agreement dated December 17, 2002 between SmartDisk and Baader North American Corporation (Fort Myers Facility) | ||
21 | .1 | Subsidiaries of SmartDisk (21.1)(7) | ||
23 | .1 | Consent of Ernst & Young LLP, Independent Certified Public Accountants | ||
23 | .2 | Consent of Greenberg Traurig, LLP (included in Exhibits 5.1 and 8.1) | ||
24 | .0 | Power of Attorney of Directors and Executive Officers (included on Signature Page)** | ||
99 | .1 | Instructions on Use of SmartDisk Corporation Subscription Certificates | ||
99 | .2 | Notice of Guaranteed Delivery | ||
99 | .3 | Form of Letter to Stockholders | ||
99 | .4 | Form of Letter to Brokers | ||
99 | .5 | Form of Letter from Brokers or Other Nominees to Beneficial Owners | ||
99 | .6 | Instructions by Beneficial Owners to Brokers or Other Nominees | ||
99 | .7 | Form of Subscription Agent Agreement between SmartDisk and American Stock Transfer & Trust Company |
(1) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s registration statement on Form S-1 (Registration No. 333-82793). |
(2) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Current Report on Form 8-K on March 21, 2000 (File No. 000-27257). |
(3) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 000-27257). |
(4) | Incorporated by reference to the exhibit in the preceding parentheses as filed with Amendment No. 1 to SmartDisk’s Annual Report on Form 10-K/A for the year ended December 31, 1999 (File No. 000-27257). |
(5) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2000 (File No. 000-27257). |
(6) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 (File No. 000-27257). |
(7) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Annual Report on Form 10-K for the year ended December 31, 2001 (File No. 000-27257). |
(8) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 000-27257). |
(9) | Incorporated by reference to the exhibit in the preceding parentheses as filed with SmartDisk’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2002 (File No. 000-27257). |
(10) | Incorporated by reference to the exhibit in the preceding parenthesis as filed with SmartDisk’s Current Report on Form 8-K dated December 24, 2002. |
* | Management Compensation Plan or Arrangement. |
** | Previously filed. |
† | Certain information in these exhibits has been omitted pursuant to a request for confidential treatment filed with the SEC. |