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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10 - Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM_________TO _________
COMMISSION FILE NUMBER: 0-22689
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SCM MICROSYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0444317
STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION IDENTIFICATION NUMBER)
160 KNOWLES DRIVE, LOS GATOS, CA 95032
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE)
(408) 370-4888
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
N/A
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [ X ] Yes [ ] No
At May 10, 2000, 14,456,316 shares of common stock were outstanding.
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ITEM I. FINANCIAL STATEMENTS
SCM MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
THREE MONTHS ENDED
MARCH 31,
-----------------------
2000 1999
-------- --------
Net revenues.................................................. $ 32,072 $ 24,361
Cost of revenues.............................................. 20,106 16,016
-------- --------
Gross margin........................................... 11,966 8,345
-------- --------
Operating expenses:
Research and development.................................. 2,721 1,849
Sales and marketing....................................... 3,871 2,629
General and administrative................................ 3,020 1,923
-------- --------
Total operating expenses............................... 9,612 6,401
-------- --------
Income from operations................................. 2,354 1,944
Interest and other, net....................................... 1,782 1,606
-------- --------
Income before income taxes and minority earnings....... 4,136 3,550
Provision for income taxes.................................... (1,241) (1,140)
Minority interest in earnings of consolidated subsidiaries.... (217) --
-------- --------
Net income............................................. $ 2,678 $ 2,410
======== ========
Net income per share:
Basic..................................................... $ 0.19 $ 0.17
Diluted................................................... $ 0.17 $ 0.16
Shares used in computing net income per share:
Basic..................................................... 14,275 14,014
Diluted................................................... 15,669 15,121
Comprehensive income:
Net income................................................ $ 2,678 $ 2,410
Unrealized gain on investment net of deferred taxes....... 622 --
Foreign currency translation adjustment................... (275) (1,481)
-------- --------
Total comprehensive income............................. $ 3,025 $ 929
======== ========
See notes to condensed consolidated financial statements.
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SCM MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
MARCH 31, DECEMBER 31,
ASSETS 2000 1999
--------- ------------
Current assets:
Cash, cash equivalents and short-term investments... $ 127,401 $ 125,409
Accounts receivable, net............................ 31,706 32,215
Inventories......................................... 18,046 15,934
Other current assets................................ 8,090 8,836
--------- ---------
Total current assets.............................. 185,243 182,394
Property and equipment, net............................. 6,473 6,372
Investments............................................. 17,103 13,945
Intangible assets, net.................................. 7,572 8,006
Other assets............................................ 319 267
--------- ---------
Total assets...................................... $ 216,710 $ 210,984
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................... $ 14,151 $ 17,679
Accrued expenses.................................... 7,286 7,806
Income taxes payable................................ 3,426 4,906
Short-term debt..................................... 1,483 1,512
--------- ---------
Total current liabilities......................... 26,346 31,903
Deferred tax liability.................................. 3,602 3,201
Minority interest....................................... 181 84
Stockholders' equity:
Capital stock....................................... 15 14
Additional paid-in capital.......................... 180,638 173,048
Retained earnings (deficit)......................... 1,326 (1,504)
Deferred compensation............................... (8) (25)
Other cumulative comprehensive income............... 4,610 4,263
--------- ---------
Total stockholders' equity........................ 186,581 175,796
--------- ---------
$ 216,710 $ 210,984
========= =========
See notes to condensed consolidated financial statements.
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SCM MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
THREE MONTHS
ENDED MARCH 31,
-----------------------
2000 1999
-------- --------
Cash flows from operating activities:
Net income............................................. $ 2,678 $ 2,410
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization...................... 1,025 533
Minority interest in earnings of subsidiaries...... 217 --
Deferred income taxes.............................. 169 --
Amortization of deferred stock compensation........ 17 15
Changes in operating assets and liabilities:
Accounts receivable............................... (431) 1,182
Inventories....................................... (4,192) (3,759)
Other current assets.............................. 1,006 (743)
Accounts payable.................................. (2,039) (2,716)
Accrued expenses.................................. (1,030) 843
Income taxes payable.............................. (996) (2,354)
-------- --------
Net cash used in operating activities........... (3,576) (4,589)
-------- --------
Cash flows provided by (used in) investing activities:
Capital expenditures................................... (954) (1,144)
Purchase of long-term investment....................... (2,000) --
Proceeds from investments.............................. 34,222 20,311
Purchases of investments............................... (15,348) (23,402)
-------- --------
Net cash provided by (used in) investing
activities...................................... 15,920 (4,235)
-------- --------
Cash flows from financing activities:
Payments on line of credit and other current debt...... (28) --
Proceeds from issuance of equity, net.................. 7,591 734
-------- --------
Net cash provided by financing activities....... 7,563 734
Effect of exchange rates on cash.......................... 255 420
-------- --------
Net increase (decrease) in cash........................... 20,162 (7,670)
Cash and cash equivalents at beginning of period.......... 45,662 48,012
-------- --------
Cash and cash equivalents at end of period................ $ 65,824 $ 40,342
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Supplemental disclosures of cash flow information:
Cash paid for income taxes............................. $ 3,029 $ 3,416
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Cash paid for interest................................. $ 21 $ 10
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See notes to condensed consolidated financial statements.
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SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2000
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulations S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered for a fair presentation have been
included. Operating results for the three-month period ended March 31, 2000 are
not necessarily indicative of the results that may be expected for the year
ending December 31, 2000. For further information, refer to the financial
statements and footnotes thereto included in SCM Microsystems' December 31, 1999
annual report on Form 10-K.
2. INVENTORIES
Inventories consist of (in thousands):
AS OF AS OF
MARCH 31, DECEMBER 31,
2000 1999
--------- ------------
Raw materials ................ $12,078 $ 9,077
Finished goods ............... 5,968 6,857
------- -------
$18,046 $15,934
======= =======
3. NET INCOME PER SHARE
Basic and diluted net income per share is computed using the weighted average
number of common shares outstanding during the period. Diluted net income per
share also includes the effect of shares issuable under stock options and
warrants.
4. RECENT ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement No.
133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No.
133"), which defines derivatives, requires that all derivatives be carried at
fair value, and provides for hedge accounting when certain conditions are met.
SFAS No. 133, as amended, is effective for fiscal years beginning after June 15,
2000. SCM does not believe adoption of this statement will have a material
impact on our consolidated financial position or results of operations.
5. ACQUISITION
Dazzle
On June 30, 1999, SCM acquired a 51% interest in Dazzle Multimedia,
Inc. ("Dazzle"), a privately held company based in Fremont, California,
in a transaction that was accounted for under the purchase method of
accounting. The results of Dazzle have been consolidated from the date
of acquisition.
6. SEGMENT REPORTING, GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS
SCM has adopted the provisions of SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information, in 1998. SFAS No. 131 establishes
standards for the reporting by public business enterprises of information about
operating segments, products and services, geographic areas, and major
customers. The method for determining what information to report is based on the
way that management organizes the operating segments within SCM for making
operating decisions and assessing financial performance. Our chief operating
decision
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maker is considered to be our executive staff, consisting of the Chief Executive
Officer, Chief Operations Officer and Executive Chairman.
The executive staff has aligned our organization along three business
segments: Digital TV, Digital Media and PC and Network Security. The executive
staff reviews financial information and business performance along these three
product segments. We evaluate the performance of our business segments at the
revenue and gross margin level. Our reporting systems do not track or allocate
operating expenses or assets by segment. We do not include intercompany
transfers between segments for management purposes.
Summary information by segment as of and for the quarter ended March 31, 2000
and 1999, is as follows (in thousands):
QUARTER ENDED
MARCH 31,
------------------------
2000 1999
-------- --------
Digital TV:
Revenues.................. $ 15,562 $ 8,954
Gross margin.............. 6,004 3,137
Digital Media:
Revenues.................. $ 11,317 $ 12,409
Gross margin.............. 3,632 3,951
PC and Network Security:
Revenues.................. $ 5,193 $ 2,998
Gross margin.............. 2,330 1,257
Geographic revenues are based on the country where the customers are
located. Information regarding revenues by geographic region as of and for the
three months ended March 31, 2000 and 1999 follows (in thousands):
2000 1999
-------- --------
United States........................ $ 15,958 $ 9,408
Europe............................... 11,404 10,448
Asia-Pacific......................... 4,710 4,505
-------- --------
$ 32,072 $ 24,361
======== ========
No customers exceeded 10% of total net revenues for the quarter ended March
31, 2000. Two customers accounted for 15% and 14% of total net revenues during
the first quarter of 1999.
7. RELATED PARTY TRANSACTIONS
In 1999, SCM loaned $3.55 million to Spyrus, Inc., an OEM customer which
provides Internet identification and encryption solutions for e-business. In
March 2000, Spyrus consummated a $20.15 million preferred stock financing. In
this transaction, SCM acquired 35,500,000 shares of Spyrus' Series B preferred
stock at a price of $0.10 per share through the conversion of the loan. This
represents approximately 15.8% of Spyrus' outstanding common stock on an as
converted basis. In connection with this transaction, three directors of SCM
acquired additional Spyrus Series B preferred stock on the same terms as SCM.
Shares held by these individuals represent approximately 3.6% of Spyrus'
outstanding common stock on an as converted basis. SCM has the right to appoint
a director to Spyrus' board of directors and a member of SCM's Board currently
serves as SCM's appointee.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that involve risks and
uncertainties. SCM's actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain factors,
including those set forth in this section as well as those discussed under the
caption "Factors That May Affect Future Operating Results" and elsewhere in this
document.
OVERVIEW
SCM Microsystems designs, develops and sells hardware, software and silicon
that enables people to conveniently and securely access digital content and
services, including content and services that have been protected through
digital encryption. We sell our products primarily into the Digital Television,
Broadband Access, PC/Network Security and Digital Media Transfer markets. Our
target customers are manufacturers in the consumer electronics, computer,
digital appliance, digital media and conditional access system industries. We
sell and license our products through a direct sales and marketing organization,
primarily to original equipment manufacturers. We also sell through
distributors, value added resellers and systems integrators worldwide.
Operationally, we have organized our business around three divisions: Digital
Television, PC/Network Security and Digital Media and Connectivity. We were
organized in Delaware in 1996.
ACQUISITION
On June 30, 1999, SCM acquired a 51% interest in Dazzle Multimedia, Inc.
("Dazzle"), a privately held company based in Fremont, California, in a
transaction that was accounted for under the purchase method of accounting. The
results of Dazzle have been consolidated from the date of acquisition.
RESULTS OF OPERATIONS
Net Revenues. Net revenues reflect the invoiced amount for goods shipped less
an allowance for estimated returns. Revenue is recognized upon product shipment.
Net revenues for the quarter ended March 31, 2000 were $32.1 million compared to
$24.4 million in 1999, an increase of 32%. The increase in revenues in the first
quarter of 2000 over the same quarter in 1999 was due primarily to an increase
in shipments of our Digital TV products of $6.6 million and an increase in
shipments of PC and Network Security products of $2.2 million, partially offset
by a $1.1 million decrease in Digital Media and Connectivity products. The
increase in Digital TV shipments primarily consisted of our new St@rKey product
as well as shipments of Dazzle product to its customers. The decrease in Digital
Media and Connectivity products was primarily due to the lack of availability of
multimedia flash memory cards for the digital music player market. Sales of
multimedia cards are tied to demand for our Digital Media readers. Sales to
SCM's top 10 customers accounted for 41% and 61% of total net revenues in the
first quarter of 2000 and 1999, respectively.
Gross Profit. Gross profit for the first quarter of 2000 was $12.0 million,
or 37% of total net revenues, compared to $8.3 million or 34% for the first
quarter of 1999. The increase in gross profit in absolute dollars for the first
quarter of 2000 was primarily due to the aforementioned increase in shipments of
Digital TV products and PC and Network Security products which carry gross
profit levels that are higher than our Digital Media products. The increase as a
percentage of total net revenues was due primarily to the product mix discussed
above. We believe that our gross profit in absolute dollars during 2000 will
continue to be above the levels experienced in 1999. Our gross profit has been
and will continue to be affected by a variety of factors, including competition,
product configuration and mix, the availability of new products, product
enhancements, software and services, and the cost and availability of
components. Accordingly, gross profit percentages are expected to fluctuate from
period to period.
Research and Development. Research and development expenses consist primarily
of employee compensation and prototype expenses. To date, the period between
achieving technological feasibility and completion of software has been short,
and software development costs qualifying for capitalization have been
insignificant. Accordingly, SCM has not capitalized any software development
costs. For the first quarter of 2000, research and development expenses were
$2.7 million, compared with $1.8 million in the first quarter of 1999, an
increase of 47%. As a percentage of total net revenues, research and development
expenses were 8% in the first quarter of 2000 and 1999. The increase in absolute
amounts was primarily due to engineering headcount and related product
development
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costs at our development centers in France and India, and to research and
development expenses of Dazzle. Personnel related expenses increased by $0.6
million and prototype expenses increased $0.3 million in the first quarter of
2000 compared to the same quarter in 1999. We believe that the absolute amount
of research and development expenses during 2000 will be higher than in 1999 due
to a higher number of personnel involved in our new product development and
customer projects, but that such expenses will fluctuate as a percentage of
total net revenues.
Sales and Marketing. Sales and marketing expenses consist primarily of
employee compensation and trade show and other marketing costs. Sales and
marketing expenses for the first quarter of 2000 were $3.9 million, or 12% of
revenues, compared with $2.6 million in the first quarter of 1999, or 11% of
revenues, an increase of 47%. These increases in absolute amounts in 2000 were
primarily due to an increase in sales and marketing costs in the U.S. and
Germany and the acquisition of Dazzle. The increases consisted primarily of
personnel related expenses of $0.6 million, external and internal sales
commissions of $0.2 million, marketing program costs of $0.2 million and travel
costs of $0.1 million. We expect sales and marketing expenses in 2000 to
increase in absolute amounts as we continue to expand our sales and business
development efforts on a worldwide basis
General and Administrative. General and administrative expenses consist
primarily of compensation expenses for employees performing SCM's administrative
functions, professional fees such as legal, audit, tax and consulting fees, and
the amortization of intangible assets. In the first quarter of 2000, general and
administrative expenses were $3.0 million, an increase of 57% compared with $1.9
million in the first quarter of 1999, and representing 9% and 8% of total net
revenues in the first quarter of 2000 and 1999, respectively. These increases in
absolute amounts in 2000 were primarily due to an increase in professional fees
of $0.3 million related to tax consulting and the roll-out of our SAP software
worldwide, an increase in intangible asset amortization of $0.3 million and an
increase in personnel fees of $0.2 million, primarily due to the acquisition of
Dazzle at the end of the second quarter of 1999. We believe general and
administrative expenses in 2000 will continue to increase in absolute amount as
we continue to improve our infrastructure, but will fluctuate as a percentage
of total net revenues.
Interest Income and Other, Net. Interest income and other, net consists of
interest earned on invested cash, offset by interest paid or accrued on
outstanding debt and foreign currency gains or losses. In the first quarter of
2000, interest income and other, net, was $1.8 million, compared to $1.6 million
in the first quarter of 1999. Foreign currency gains for the first quarter of
2000 and 1999 was $0.1 million. The increase in interest income and other, net
is primarily due to interest income on higher cash balances during the first
quarter of 2000.
Income Taxes. The provision for income taxes in the first quarter of 2000 was
$1.2 million, or 30% of income before tax, compared to 33% for all of 1999.
SCM's tax rate is effected by the mix of taxable income among the various tax
jurisdictions in which we do business.
Minority interest. The minority interest of $217,000 in the first quarter of
2000 reflects the proportional profits that are attributable to the minority
shareholders in two of SCM's subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2000, our working capital was $158.9 million, compared to
working capital of $150.5 million as of December 31, 1999. Working capital
increased in the first three months of 2000 primarily due to the net proceeds
from the exercise of stock options.
During the first three months of 2000, cash and cash equivalents increased by
$20.2 million due primarily to $15.9 million provided by investing activities
and $7.6 million by financing activities being offset by a use of cash of $3.6
million in operations. The cash provided by investing activities was primarily
from net proceeds of $18.9 million from short-term investments, offset by the
purchase of $2.0 million of long-term investments and $1.0 million of capital
expenditures. The $7.6 million of cash provided by financing activities was
primarily from proceeds from the exercise of stock options. Cash used in
operations of $3.6 million was primarily from an increase in inventories of $4.2
million, and decreases in accounts payable of $2.0 million and accruals of $1.0
million, more than offsetting income from operations of $3.7 million after
adding back depreciation and amortization.
SCM has revolving lines of credit with two banks in Germany providing total
borrowings of up to DM 3,000,000 (approximately $1,468,000 as of March 31,
2000). Neither line has an expiration date. The German
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lines of credit bear interest at rates ranging from 6.75% to 11.25%, and
borrowings under these lines of credit are unsecured. In the United States, we
have an unsecured $3,000,000 line of credit which bears interest at 8.5% and
expires in May 2001. In addition, we have a Singapore $1,200,000 (approximately
$701,000 as of March 31, 2000) overdraft facility with a local bank due on
demand. The Singapore line is secured by a U.S. $380,000 fixed deposit and has a
base interest rate of 6.5%. Japan also has a 67 million yen (approximately
$652,000 as of March 31, 2000) line of credit with a local bank that is renewed
annually for one year each June. The Japanese line has an interest rate of
1.625% and is secured by a 67 million yen deposit. At March 31, 2000, no amounts
were outstanding under any of our lines of credit. The short-term debt consists
primarily of $1.4 million of convertible notes issued by Dazzle, convertible
into Series B Preferred Stock of Dazzle at any time prior to maturity, at the
election of the note holder. The notes mature on June 30, 2000.
We believe that our current capital resources and available borrowings should
be sufficient to meet our operating and capital requirements through at least
the end of 2000. We may, however, seek additional debt or equity financing prior
to that time. We can not assure you that additional capital will be available to
SCM on favorable terms or at all. The sale of additional debt or equity
securities may cause dilution to existing stockholders.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing SCM. Additional risks and uncertainties not presently known to
us or that we currently deem immaterial may also impair our business operations.
If any of the following risks actually occur, our business, financial
condition or results of operations could be materially adversely affected. In
such case, the trading price of our common stock could decline and you could
lose all or part of your investment.
WE HAVE INCURRED OPERATING LOSSES AND MAY NOT REMAIN PROFITABLE.
Although SCM was profitable for the quarters ended March 31, 2000, December
31,1999, September 30, 1999 and March 31, 1999 and for the year ended December
31, 1997, we incurred net operating losses on an annual basis from our inception
in 1993 through the year ended December 31, 1996, as well as in 1998. We also
incurred an operating loss in the quarter ended June 30, 1999. As of March 31,
2000, SCM had an accumulated earnings of $1.3 million. In view of our loss
history, we cannot assure you that we will be able to achieve or sustain
profitability on an annual or quarterly basis in the future.
Our quarterly operating results depend on a number of factors that are
difficult to forecast. If our future quarterly operating results fall below the
expectations of securities analysts or investors, the trading price of our
common stock will likely drop. Our quarterly operating results have fluctuated
in the past and may continue to fluctuate in the future as a result of many
factors, including:
- - size, timing, cancellation or rescheduling of significant orders;
- - new product announcements or introductions by us or our competitors;
- - our ability to develop, introduce and market new products and product
enhancements on a timely basis, if at all;
- - our success in expanding our sales and marketing organization and programs;
- - technological changes in the market for our products;
- - our level of expenditures on research and development; and
- - general economic trends.
In addition, because a high percentage of our operating expenses are
fixed, a small variation in revenue can cause significant variations in our
operating results from quarter to quarter. SCM's operating results may vary
significantly in future periods and our historical results may not be a
reliable indicator of our future performance.
SEASONAL TRENDS IN SALES OF OUR PRODUCTS MAY AFFECT OUR QUARTERLY OPERATING
RESULTS.
Our business and operating results reflect seasonal trends. We have
typically experienced lower net revenue and operating income in the first
quarter and second quarter and higher net revenue in the third quarter and
fourth
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quarter of each calendar year. We believe that the seasonal trends in our
business and operating results are primarily due to two factors. The first is
the retail selling cycles of our OEM customers in our Digital Media and Digital
TV businesses. SCM sells readers for digital cameras and Internet music players
in the U.S. and digital video broadcasting products in Europe. Because OEMs
typically bundle our devices into their consumer products, and because the
market for consumer products is stronger in the second half of the year, our
business is impacted as well. We expect that our sales to consumer-oriented OEMs
will increase, and the seasonal trends that effect our business and operating
results will continue. The second factor is related to the budgeting cycle of
the U.S. government, which is heavily weighted to the second half of the
calendar year. Because OEMs incorporate our data security products into PCs and
workstations that are then sold to the U.S. government, the government's budget
cycle influences the dynamics of our business as well.
OUR TARGET MARKETS MAY NOT ACCEPT OUR PRODUCTS.
SCM's future growth and operating results will depend on whether our
products are commercially successful. As described below, each of our product
families address needs in different emerging markets. We may not succeed in
these emerging markets. In addition, as these markets develop, industry
standards may be established. Our products may not comply with the industry
standards ultimately adopted in these emerging markets.
We sell security and connectivity products across four target markets:
Digital TV, Broadband Access, PC/Network Security and Digital Media Transfer. In
the Digital Media Transfer market, our reader and connectivity products provide
easy to use, high-speed connections between digital platforms, such as PCs and
digital cameras, and electronic media, such as copyright-protected music from
the Internet. If the benefits of rapid transfer of digital photographs or music
are not perceived as sufficient, then demand for products such as ours may not
grow.
In the PC/networking security market, smart card-based security applications
are beginning to be adopted by computer makers and software providers. Smart
card token-based security applications provide protection from unauthorized
access to digital information. Our SwapBox and SwapSmart product families are
designed to provide smart card-based security for PCs. However, the market for
network and electronic commerce security applications is still emerging and the
smart card may not become the industry standard; hence other token architectures
or other security approaches may be selected for these applications.
In the Digital TV market, our products provide a means of controlling access
to digital television broadcasts. Our DVB-CAM products provide conditional
access functionality while adhering to the European DVB-CI and U.S. NRSS-B
standards. To date, our DVB-CAM products have been implemented in a relatively
limited number of Digital TV set-top boxes in Europe. However, the European
standard for Digital TV conditional access applications is still emerging.
Although we believe that the DVB-CI standard will eventually become the European
standard for Digital TV conditional access applications, this standard may not
be adopted and the European Digital TV market may fail to further develop. In
the United States, the market for Digital TV conditional access products has
only recently begun to develop and may not grow. In addition, the substantial
base of proprietary analog set-top boxes already installed in the U.S. may cause
the market for Digital TV conditional access products in general, and our
products in particular, to grow more slowly than expected or not at all.
In the market for broadband access, our products provide a means of
accessing high bandwidth content on the PC utilizing the broadband satellite
network. If other solutions address this demand more quickly, more cost
effectively or more conveniently than our products, or if we are unable to
development sufficient relationships with partners to distribute our products,
then our broadband access business may not grow.
If the market for the products described above or any of our other products
fail to develop or develop more slowly than expected, or if any of the standards
supported by us do not achieve or sustain market acceptance, our business and
operating results would be materially and adversely affected.
WE DEPEND UPON SALES TO ORIGINAL EQUIPMENT MANUFACTURERS AND DISTRIBUTORS.
Most of our products are intended for use as components subsystems or
value-added devices in systems manufactured and sold by third party original
equipment manufacturers, or OEMs. In order to convince an OEM to incorporate our
products into its systems, we must demonstrate that our products provide
significant commercial advantages over alternative solutions. We may fail to
successfully demonstrate these advantages or our products may cease to provide
any advantages. Even if we are able to demonstrate that our products are
superior, OEMs may
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still choose not to incorporate our products into their systems. OEMs may also
change their business strategies and manufacturing practices, which could cause
them to purchase fewer units of our products, find other sources for products we
currently manufacture or manufacture these products internally. Our OEM
customers may also seek price concessions from us. Failure of OEMs to
incorporate our products into their systems, the failure of such OEMs' systems
to achieve market acceptance or any other event causing a decline in our sales
to OEMs would have a material adverse effect on our business and operating
results.
Sales of some of our Digital Media and PC/Network Security products are made
to distributors, some of whom are smaller companies with limited working capital
for marketing and promotion efforts and whose cash flow is dependent on payment
from their customers. We believe that delays in shipments by and payments to our
distribution customers by their customers may have a material adverse effect on
our business and operating results.
A SIGNIFICANT PORTION OF OUR SALES COMES FROM A SMALL NUMBER OF CUSTOMERS
Our products are targeted at OEM consumer electronics, computer, digital
appliance, digital media and conditional access system manufacturers. Sales to a
relatively small number of customers historically have accounted for a
significant percentage of our total sales. Sales to our top 10 customers
accounted for approximately 41% of our total net revenues in the first quarter
of 2000. No customer exceeded 10% of our revenues in the first quarter of 2000.
We expect that sales of our products to a limited number of customers will
continue to account for a high percentage of our total sales for the foreseeable
future. The loss or reduction of orders from a significant customer, including
losses or reductions due to manufacturing, reliability or other difficulties
associated with our products, changes in customer buying patterns, or market,
economic or competitive conditions in the digital information security business,
could harm our business and operating results.
WE RELY ON OUR STRATEGIC RELATIONSHIPS TO GENERATE REVENUE.
SCM collaborates with a number of corporations and is a member of key
industry consortia. Our future success will depend significantly on the success
of our current arrangements and our ability to establish additional
arrangements. We have formed strategic relationships, including technology
sharing agreements, with a number of key industry players such as Intel,
Microsoft and SanDisk. We evaluate, on an ongoing basis, potential strategic
alliances and intend to continue to pursue such relationships. These
arrangements may not result in commercially successful products.
OUR SALES TO GOVERNMENT CONTRACTORS ARE SUBJECT TO UNCERTAINTIES AND MAY
DECREASE.
Approximately 3%, 8%, 12% and 17%, of our net revenues for the quarter ended
March 31, 2000 and the years ended 1999, 1998 and 1997, respectively, were
derived from sales of our SwapBox product for use by the U.S. government. These
sales were made under contracts between SCM and major OEMs that sell PCs to the
United States Department of Defense, or DOD. We believe that indirect sales to
the DOD are subject to a number of significant uncertainties, including timing
and availability of funding, unpredictable changes in the timing and quantity of
orders and the generally competitive nature of government contracting.
Furthermore, the DOD has been reducing total expenditures over the past few
years in several areas. Accordingly, funding for the purchase of our products
may be reduced in the future. In addition, we may not be able to modify existing
products or develop new products that will continue to meet the specifications
of OEM suppliers to the DOD. A significant loss of indirect sales to the U.S.
government would have a material adverse effect on our business and operating
results.
OUR MARKETS ARE HIGHLY COMPETITIVE.
The market for our products is intensely competitive and characterized by
rapidly changing technology. We believe that competition in this market is
likely to intensify as a result of increasing demand for digital data security,
access control and connectivity products. We currently experience competition
from a number of sources, including:
- - PubliCard in DVB-CAM modules;
- - Pinnacle in digital video creation;
- - ActionTec, Carry Computer Engineering, Greystone and Litronic in PC Card
adapters;
- - Gemplus, Litronic, PubliCard and Towitoka in smart card readers and
universal smart card reader interfaces; and
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- - Carry Computer Engineering, DataFab and SmartDisk for digital media readers
and connectivity.
We also experience indirect competition from some of our customers which
sell alternative products or are expected to introduce competitive products in
the future. We may in the future face competition from these competitors and new
competitors, such as Motorola, that develop digital information security
products. In addition, the market for digital data security, access control and
connectivity products may ultimately include technological solutions other than
ours.
Many of our current and potential competitors have significantly greater
financial, technical, marketing, purchasing and other resources than we do. As a
result, our competitors may be able to respond more quickly to new or emerging
technologies or standards and to changes in customer requirements. Our
competitors may also be able to devote greater resources to the development,
promotion and sale of products, and may be 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.
We believe that the principal competitive factors affecting the market for
digital data security and connectivity products include:
- - the extent to which products comply with existing industry standards;
- - technical features;
- - ease of use;
- - quality and reliability;
- - level of security;
- - strength of distribution channels; and
- - price.
We may not be able to successfully compete as to these or other factors and the
competitive pressures may cause our business and operating results to suffer.
ANY DELAYS IN OUR NORMALLY LENGTHY SALES CYCLE COULD RESULT IN SIGNIFICANT
FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS.
When we obtain a new OEM customer, our initial sales to that customer
usually take six to nine months. During this sales cycle, we may expend
substantial financial resources and our management's time and effort with no
assurance that a sale will ultimately result. The length of a new OEM customer's
sales cycle depends on a number of factors that we may not be able to control.
These factors include the customer's product and technical requirements and the
level of competition we face for that customer's business. Any delays in the
sales cycle for new customers could have a material adverse effect on our
business and operating results.
WE HAVE EXPERIENCED SIGNIFICANT GROWTH IN OUR BUSINESS IN RECENT PERIODS AND WE
MAY NOT BE ABLE TO MANAGE THIS GROWTH OR ANY FUTURE GROWTH.
Our business has grown substantially in recent periods, with net revenues
increasing from $10.9 million in 1994 to $127.3 million 1999 and revenues of
$32.1 million in the first quarter of 2000. We have expanded our focus from the
PC/Network Security market to include Digital TV, Digital Media Transfer and
more recently Broadband Access. Managing business in each of these markets
requires skilled management, significant attention and substantial resources. To
address our need for additional resources and because of acquisitions, we have
increased in size from 67 employees at December 31, 1995 to 389 as of March 31,
2000. The growth of our business places a significant strain on our management
and operations.
If we are successful in achieving our growth plans, our growth is likely to
continue to place a significant burden on our operating and financial systems
and increased responsibility for senior management and other personnel. Existing
management or any new members of management may not be able to improve existing
systems
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and controls or implement new systems and controls in response to anticipated
growth. Our failure to do so could have a material adverse effect on our
business and operating results.
WE ARE CONSOLIDATING A MAJORITY OWNED SUBSIDARY.
Effective June 30th 1999, SCM purchased 51% of Dazzle Multimedia Inc., which
will continue to be operated as a separate entity. Although SCM has a majority
of the voting stock of Dazzle Multimedia, has representation on the board of
directors and is financing the company, our control of Dazzle is subject to our
fiduciary duty to its minority shareholders. Consequently, the decisions we make
on behalf of Dazzle may not always not be in line with our goals for SCM. This
could have a significant impact on the operations of Dazzle and consequently
SCM.
The financial results of Dazzle are being consolidated in SCM's results.
Dazzle Multimedia has been profitable in each quarter since its acquisition, and
SCM has and will continue to recognize in our consolidated financial results
that portion of Dazzle profit that is attributable to the minority shareholders.
OUR GLOBAL LOCATIONS MUST WORK TOGETHER EFFECTIVELY.
SCM's U.S. headquarters are located in Los Gatos, California. European
headquarters are located in Pfaffenhofen, Germany. We have sales offices in
Wokingham, England, and research and development facilities in La Ciotat, France
and Pondicherry and Madras, India. In Asia, we have manufacturing facilities in
Singapore and sales offices in Taiwan and Tokyo, Japan. Operating in diverse
geographic locations imposes a number of risks and burdens on us, including the
need to manage employees and contractors from diverse cultural backgrounds and
who speak different languages, and difficulties associated with operating in a
number of time zones. Although these difficulties can be reduced through the use
of electronic mail and teleconferencing, unforeseen difficulties or logistical
barriers in operating in diverse locations may occur. Operating in widespread
geographic locations requires us to implement and operate complex information
and operational systems. Although we believe that our systems are adequate, in
the future we may have to implement new systems. Implementation of new
information systems, in particular, may be costly. Any failure or delay in
implementing needed systems, procedures and controls on a timely basis or in
expanding current systems in an efficient manner could have a material adverse
effect on our business and operating results.
WE MAY BE EXPOSED TO RISKS OF INTELLECTUAL PROPERTY INFRINGEMENT.
SCM's success depends significantly upon our proprietary technology. We
currently rely on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality agreements and contractual provisions to protect our
proprietary rights. Our software, documentation and other written materials are
protected under trade secret and copyright laws, which afford only limited
protection. SCM generally enters into confidentiality and non-disclosure
agreements with our employees and with key vendors and suppliers. For example,
our SwapBox and SwapSmart trademarks are registered in the United States. We
continuously evaluate the registration of additional trademarks as appropriate.
We currently have seven United States patents issued and five European patents
issued. We also have nineteen patent applications pending worldwide. In
addition, we have exclusive licenses under four other United States patents, and
licenses for two United States patents associated with our products. Although we
often seek to protect our proprietary technology through patents, it is possible
that no new patents will be issued, that our proprietary products or
technologies are not patentable, and that any issued patent will fail to provide
us with any competitive advantages.
There has been a great deal of litigation in the technology industry
regarding intellectual property rights. Litigation may be necessary to protect
our proprietary technology. SCM has from time to time received claims that it is
infringing upon third parties' intellectual property rights and future disputes
with third parties may not be resolved on terms acceptable to us. As the number
of products and competitors in our target markets grows, the likelihood of
infringement claims also increases. Any claims or litigation may be
time-consuming and costly, cause product shipment delays, or require us to
redesign our products or require us to enter into royalty or licensing
agreements. Any of these events could have a material adverse effect on our
business and operating results. Despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy aspects of our products or to
use our proprietary information and software. In addition, the laws of some
foreign countries do not protect proprietary and intellectual property rights to
as great an extent as do the laws of the United States. Our means of protecting
our proprietary and intellectual property rights may not be adequate. There is a
risk that our competitors will independently develop similar technology,
duplicate our products or design around patents or other intellectual property
rights.
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OUR BUSINESS COULD SUFFER IF WE OR OUR CONTRACT MANUFACTURERS CANNOT MEET
PRODUCTION REQUIREMENTS.
We are designing and manufacturing new products and technologies to address
emerging markets that are early in their life cycles. In many cases our products
are the first of their kind to address the evolving business requirements of our
customers. While we perform initial beta testing on all our products, in certain
cases we are unable to test the efficacy of the design or functionality of our
products for mass production. If we are successful in securing large contracts
for our products, we cannot be certain that we will be able to produce them in
sufficient quantities and that they will meet customer specifications.
In addition, most of our products are manufactured outside the United States
because we believe that global sourcing enables us to achieve greater economies
of scale, improve gross margins and maintain uniform quality standards for our
products. Any significant delay in our ability to obtain adequate supplies of
our products from our current or alternative sources would materially and
adversely affect our business and operating results. In an effort to reduce our
manufacturing costs, SCM has shifted volume production of many of our product
components to our wholly owned subsidiary in Singapore, SCM Microsystems (Asia)
Pte. Ltd., formerly Intellicard. In addition, we utilize contract manufacturers
in Europe and Asia. Foreign manufacturing poses a number of risks, including
transportation delays and interruptions, difficulties in staffing, currency
fluctuations, potentially adverse tax consequences and unexpected changes in
regulatory requirements, tariffs and other trade barriers, and political and
economic instability. If we or any of our contract manufacturers cannot meet our
production requirements, we may have to rely on other contract manufacturing
sources or identify and qualify new contract manufacturers. 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.
WE HAVE A LIMITED NUMBER OF SUPPLIERS OF KEY COMPONENTS.
We rely upon a limited number of suppliers of several key components of our
products. For example, SCM purchases mechanical components for use in our smart
card reader product exclusively from Stocko, a German-based supplier. Our
reliance on only one supplier could impose several risks, including an
inadequate supply of components, price increases, late deliveries and poor
component quality. Disruption or termination of the supply of these components
could delay shipments of our products, which could have a material adverse
effect on our business and operating results. These delays could also damage
relationships with current and prospective customers.
THE MARKETS FOR OUR PRODUCTS MAY UNDERGO RAPID TECHNOLOGICAL CHANGE AND OUR
FUTURE SUCCESS WILL DEPEND ON OUR ABILITY TO MEET THE SOPHISTICATED NEEDS OF OUR
CUSTOMERS.
The markets for our products are characterized by rapidly changing technology.
Our customers' needs change and new products are introduced frequently. Product
life cycles are short and industry standards are still evolving. These rapid
changes in technology could render our existing products obsolete and
unmarketable. Therefore, our future success will depend upon our ability to
successfully develop and introduce new and enhanced products that meet our
customers' increasing expectations and incorporate the latest technology.
Product development is risky because it is difficult to foresee developments in
technology, coordinate technical personnel and identify and eliminate design
flaws. Any significant delay in releasing new products could have a material
adverse effect on the ultimate success of our products and could reduce sales of
predecessor products. We may not be able to introduce new products on a timely
basis. In addition, new products introduced by us may fail to achieve a
significant degree of market acceptance or, once accepted, may fail to sustain
viability in the market for any significant period. These factors could have a
material adverse effect on our business and operating results.
MANY OF OUR CUSTOMERS ARE LOCATED IN OTHER COUNTRIES WHICH EXPOSES OUR BUSINESS
TO RISKS RELATED TO INTERNATIONAL SALES AND CURRENCY FLUCTUATIONS.
SCM was originally a German corporation and continues to conduct a
substantial portion of our business in Europe. Approximately 50%, 52%, 62%, and
51% of our revenues for the quarter ended March 31, 2000 and the years ended
1999, 1998, and 1997, respectively, were derived from customers located outside
the United States. Because a significant number of our principal customers are
located in other countries, we anticipate that international sales will continue
to account for a substantial portion of our revenues. As a result, a significant
portion of our sales and operations may continue to be subject to certain risks,
including:
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- - tariffs and other trade barriers;
- - difficulties in staffing and managing disparate branch operations;
- - currency exchange risks;
- - exchange controls; and
- - potential adverse tax consequences.
These factors may have a material adverse effect on our business and operating
results.
We conduct operations and sell products in several different countries. Over
the last two years, we have acquired companies in Japan, Singapore, Great
Britain and India. Therefore, our operating results may be impacted by the
fluctuating exchange rates of foreign currencies, especially the German mark,
the Japanese yen, the Singapore dollar, the British pound and the Indian rupee,
in relation to the U.S. dollar. We do not currently engage in hedging activities
with respect to our foreign currency exposure. We continually monitor our
exposure to currency fluctuations and may use financial hedging techniques when
appropriate to minimize the effect of these fluctuations. Even so, exchange rate
fluctuations may still have a material adverse effect on our business and
operating results. 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.
WE MAY FACE PRODUCT LIABILITY RISKS.
Customers rely on our token-based security products to prevent unauthorized
access to their digital information. A malfunction of or design defect in our
products could result in legal or warranty claims. Although we place warranty
disclaimers and liability limitation clauses in our sales agreements and
maintain product liability insurance, we cannot assure you that these measures
will be effective in limiting our liability. Liability for damages resulting
from security breaches could be substantial and could have a material adverse
effect on our business and operating results. In addition, a well-publicized
security breach involving token-based and other security systems could adversely
affect the market's perception of products like ours in general, or our products
in particular, regardless of whether the breach is actual or attributable to our
products. In that event, the demand for our products could decline, which would
cause our business and operating results to suffer.
OUR KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS AND SUCH KEY PERSONNEL MAY NOT
REMAIN WITH SCM IN THE FUTURE.
We depend on the continued employment of our senior executive officers and
other key management and technical personnel. If any of our key personnel leave
and are not adequately replaced, our business would be adversely affected. In
particular, we depend on the continued service of Steven Humphreys, our Chairman
of the Board, Robert Schneider, our Chief Executive Officer, and Bernd Meier,
our President and Chief Operations Officer. SCM provides compensation incentives
such as bonuses, benefits and option grants (which are typically subject to
vesting over four years) to attract and retain qualified employees. In addition,
our German subsidiary has entered into substantially similar employment
agreements with each of Messrs. Schneider and Meier pursuant to which each
serves as a Managing Director of the subsidiary. Each of the respective
agreements has no set termination date, may be terminated by the subsidiary or
the officer with nine months notice, and provides that the officer cannot work
for one of our competitors during the one-year period following his termination.
Non-compete agreements are, however, generally difficult to enforce. Therefore,
these provisions may not provide us with significant protection.
We believe that our future success will depend in large part on our
continuing ability to attract and retain highly qualified technical and
management personnel. Competition for such personnel is intense, and we may not
be able to retain our key technical and management employees or to attract,
assimilate or retain other highly qualified technical and management personnel
in the future.
OUR STOCK PRICE IS POTENTIALLY VOLATILE.
The stock market has recently experienced significant price and volume
fluctuations unrelated to the operating performance of particular companies. In
addition, the market price of our common stock has been highly volatile and is
likely to continue to be volatile. The future trading price for our common stock
will depend on a number of factors, including:
- - variations in our financial results;
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- - comments and forecasts by security analysts;
- - our ability to effectively manage our business;
- - expected or announced relationships with other companies;
- - any loss of key management;
- - announcements of technological innovations or new products by us or our
competition; and
- - patents or other proprietary rights or patent litigation.
In the past, companies that have experienced volatility in the market price of
their stock have been the object of securities class action litigation. If we
were the object of securities class action litigation, it could result in
substantial costs and a diversion of management's attention and resources.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FOREIGN CURRENCIES
We conduct operations and sell products in several different countries.
Therefore, our operating results may be impacted by the fluctuating exchange
rates of foreign currencies, especially the German mark, the Japanese yen, the
Singapore dollar, the British pound and the Indian rupee, in relation to the
U.S. dollar. We do not currently engage in hedging activities with respect to
our foreign currency exposure. We continually monitor our exposure to currency
fluctuations and may use financial hedging techniques when appropriate to
minimize the effect of these fluctuations. Even so, exchange rate fluctuations
may still have a material adverse effect on our business and operating results.
FIXED INCOME INVESTMENTS
SCM's exposure to market risk for changes in interest rates relates
primarily to our investment portfolio. We do not use derivative financial
instruments for speculative or trading purposes. We place our investments in
instruments that meet high credit quality standards, as specified in our
investment policy. The policy also limits the amount of credit exposure to any
one issue, issuer and type of instrument. We do not expect any material loss
with respect to our investment portfolio.
We do not use derivative financial instruments in our investment portfolio
to manage interest rate risk. We do, however, limit our exposure to interest
rate and credit risk by establishing and strictly monitoring clear policies and
guidelines for our fixed income portfolios. At the present time, the maximum
duration of all portfolios is limited to two years. The guidelines also
establish credit quality standards, limits on exposure to one issue, issuer, as
well as the type of instrument. Due to the limited duration and credit risk
criteria established in our investment guidelines, the exposure to market and
credit risk is not expected to be material.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS ON SENIOR SECURITIES
Not applicable.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the first quarter
of 2000.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SCM MICROSYSTEMS, INC.
Date: May 12, 2000
/s/ ANDREW WARNER
-------------------------------------------
Andrew Warner
Vice President, Finance and Chief Financial
Officer (Principal Financial and Accounting
Officer)
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INDEX TO EXHIBITS
EXHIBIT DESCRIPTION
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27.1 Financial Data Schedule