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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 JUNE 30, 1998
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)
131 ALBRIGHT WAY, 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 July 31, 1998, 13,132,576 shares of common stock were outstanding.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SCM MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except per share data)
Quarter Ended Six Months Ended
June 30 June 30
------------------------- -------------------------
1998 1997 1998 1997
-------- -------- -------- --------
Net sales:
Security and access products $ 10,593 $ 5,618 $ 18,408 $ 9,820
PCMCIA peripheral products -- -- -- 163
-------- -------- -------- --------
Total net sales 10,593 5,618 18,408 9,983
Cost of sales 6,411 3,322 11,327 6,126
-------- -------- -------- --------
Gross profit 4,182 2,296 7,081 3,857
-------- -------- -------- --------
Operating expenses:
Research and development 857 790 1,623 1,418
Sales and marketing 1,181 1,038 2,225 2,013
General and administrative 1,420 585 2,198 1,133
In-process research and development 5,941 -- 5,941 --
Other acquisition integration expenses 581 -- 581 --
-------- -------- -------- --------
Total operating expenses 9,980 2,413 12,568 4,564
-------- -------- -------- --------
Loss from operations (5,798) (117) (5,487) (707)
Interest income and other, net 1,660 261 2,388 297
-------- -------- -------- --------
Income (loss) before income taxes (4,138) 144 (3,099) (410)
Provision for income taxes 620 -- 870 --
-------- -------- -------- --------
Net income (loss) (4,758) 144 (3,969) (410)
Accretion on redeemable convertible
preferred stock -- (318) -- (478)
-------- -------- -------- --------
Net loss attributable to common stockholders $ (4,758) $ (174) $ (3,969) $ (888)
======== ======== ======== ========
Net loss per share:
Basic $ (0.38) $ (0.09) $ (0.34) $ (0.53)
======== ======== ======== ========
Diluted $ (0.38) $ (0.09) $ (0.34) $ (0.53)
======== ======== ======== ========
Shares used in computing net loss per share:
Basic 12,520 1,884 11,664 1,684
======== ======== ======== ========
Diluted 12,520 1,884 11,664 1,684
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
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SCM MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
June 30, December 31,
ASSETS 1998 1997
--------- ---------
Current assets:
Cash and cash equivalents $ 43,378 $ 25,552
Short-term investments 91,199 30,336
Accounts receivable 11,890 6,607
Inventories 5,480 3,392
Prepaids and other current assets 1,166 302
--------- ---------
Total current assets 153,113 66,189
Property, equipment and other assets, net 2,348 1,176
Goodwill 7,275 --
--------- ---------
Total assets $ 162,736 $ 67,365
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable -- 9
Accounts payable 5,960 4,308
Accrued expenses 2,600 1,271
Income taxes payable 1,174 305
--------- ---------
Total current liabilities 9,734 5,893
Stockholders' equity:
Capital Stock 13 11
Additional paid-in capital 165,296 69,902
Accumulated deficit (11,683) (7,714)
Deferred compensation (97) (125)
Other cumulative comprehensive loss (527) (602)
--------- ---------
Total stockholders' equity 153,002 61,472
--------- ---------
$ 162,736 $ 67,365
========= =========
See accompanying notes to condensed consolidated financial statements.
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SCM MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in thousands)
SIX-MONTH PERIODS
ENDED JUNE 30,
-------------------------
1998 1997
-------- --------
Cash flows from operating activities:
Net loss $ (3,969) $ (410)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 378 243
Charge off of in-process research and development 5,941 --
Amortization of deferred employee compensation 28 33
Changes in operating assets and liabilities:
Accounts receivable (2,840) (956)
Inventories (741) (302)
Prepaid expenses (944) (234)
Accounts payable (1,351) (190)
Accrued expenses 527 181
Income taxes payable 869 --
-------- --------
Net cash used in operating activities (2,102) (1,635)
-------- --------
Cash flows used in investing activities:
Capital expenditures (404) (265)
Businesses acquired, net of cash received (9,875) --
Proceeds from short-term investments 16,462 --
Purchases of short-term investments (75,325) --
-------- --------
Net cash used in investing activities (69,142) (265)
-------- --------
Cash flows from financing activities:
Payments on notes payable (26) (1,290)
Principal payments on long-term debt (288) (63)
Proceeds from issuance of redeemable
convertible preferred stock -- 12,085
Proceeds from issuance of common stock, net 89,431 --
-------- --------
Net cash provided by financing activities 89,117 10,732
-------- --------
Effect of exchange rates on cash (47) (483)
-------- --------
Net increase in cash 17,826 8,349
Cash at beginning of period 25,552 2,593
-------- --------
Cash at end of period $ 43,378 $ 10,942
======== ========
See accompanying notes to condensed consolidated financial statements.
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SCM MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
($ in thousands)
SIX-MONTH PERIODS
ENDED JUNE 30,
--------------------------------
1998 1997
------------ ------------
Supplemental disclosures of cash flow information:
Cash paid during the period - interest $ 4 $ 65
============ ============
Noncash financing activities:
Businesses acquired for common stock $ 5,976 $ --
============ ============
Interest accretion on redeemable convertible
preferred stock $ -- $ 477
============ ============
Conversion of related party and non-related party debt
into redeemable convertible preferred stock $ -- $ 4,240
============ ============
See accompanying notes to condensed consolidated financial statements.
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SCM MICROSYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1998
1. BASIS OF PRESENTATION
The accompanying unaudited 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 June 30, 1998 are not necessarily indicative of
the results that may be expected for the year ending December 31, 1998. For
further information, refer to the financial statements and footnotes
thereto included in the Company's December 31, 1997 annual report on Form
10-K.
2. NET LOSS PER SHARE
Basic and diluted net loss per share is computed using the weighted average
number of common shares outstanding during the period. Diluted net loss per
share does not include the effect of 921,000 and 946,000 shares issuable
under stock options and warrants, using the treasury stock method, as of
June 30, 1998 and 1997, respectively, because their inclusion would be
antidilutive. Such options and warrants had an average exercise price of
$13.00 per share as of June 30, 1998 and $0.32 per share as of June 30,
1997. In addition, diluted net loss per share for the three and six-month
periods ended June 30, 1997 does not include 4,799,000 shares of
convertible preferred stock because their inclusion would be antidilutive.
3. COMPREHENSIVE INCOME
In June 1997 the Financial Accounting Standards Board (FASB) issued SFAS
No. 130, "Reporting Comprehensive Income" (SFAS No. 130), which establishes
standards for reporting and disclosure of comprehensive income and its
components (revenues, expenses, gains and losses) in a full set of
general-purpose financial statements. SFAS No. 130 is effective for fiscal
years beginning after December 15, 1997 and requires reclassification of
financial statements for earlier periods to be provided for comparative
purposes. The Company has not determined the manner in which it will
present the information required by SFAS No. 130 in its annual financial
statements for the year ending December 31, 1998. The Company's total
comprehensive income for the three and six month periods ended June 30,
1998 was $280,000 and $75,000, respectively. The Company's total
comprehensive loss for the three and six month periods ended June 30, 1997
was $237,000 and $407,000, respectively. In all periods, total
comprehensive income (loss) consists entirely of changes in the Company's
cumulative translation adjustment account.
4. SALE OF STOCK
In April 1998, the Company completed a follow-on public offering of 3.45
million shares of Common Stock at a price to the public of $61.00 per
share. Of the total number of shares sold, 2.0 million shares were sold by
shareholders and 1.45 million shares were sold by the Company. The net
proceeds to the Company approximated $83 million.
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5. BUSINESS COMBINATIONS
On May 19, 1998, the Company acquired all of the outstanding capital stock
of Intermart Systems K.K. ("Intermart"). Total consideration paid was $8
million, with $4.9 million paid in cash and the balance paid upon the
issuance of 46,551 shares of the Company's stock. In addition, the former
shareholders of Intermart can potentially earn an additional $4 million in
stock if certain performance criteria are met during the year ended March
31, 1999.
On June 3, 1998, the Company acquired all of the outstanding capital stock
of Intellicard Systems Pte. Ltd. ("ICS"). Total consideration paid was
$18.4 million, of which $14.9 million was paid in cash and $3.5 million was
paid upon the issuance of 61,185 shares of the Company's stock.
Approximately $11.4 million of the cash portion of the consideration was
paid in exchange for cash and a $2.0 million shareholder note held by ICS
at the closing of the transaction. The note was repaid by the shareholder
prior to June 30, 1998.
The acquisitions of Intermart and ICS were both accounted for pursuant to
the purchase method of accounting. Accordingly, the historical financial
statements of the Company exclude the assets and liabilities, results of
operation and cash flows of Intermart and ICS for all periods ending at or
prior to the respective dates of acquisition. The assets and liabilities of
Intermart and ICS were recorded at their fair values at the respective
acquisition dates. The aggregate fair value of Intermart's and ICS'
research and development efforts that had not reached technological
feasibility as of the respective dates of acquisition and had no
alternative future uses was determined by appraisal to be $5.9 million, and
was expensed at the respective dates of the acquisitions.
The following summary, prepared on a pro forma basis, combines the
Company's consolidated results of operations with Intermart's and ICS'
results of operations for the three month and six month periods ended June
30, 1998 and 1997, as if each company had been acquired as of the
beginning of the periods presented. The table includes the impact of
certain adjustments including the elimination of the non-recurring charge
for acquired in-process research and development, elimination of
intercompany profit and additional amortization relating to intangible
assets acquired (in thousands, except per share data):
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
1998 1997 1998 1997
-------- -------- -------- --------
Revenues $ 11,726 $ 7,704 $ 22,662 $ 13,653
Net income (loss) $ 2,343 $ 106 $ 3,353 $ (652)
Net income (loss)
per share:
Basic $ 0.19 $ 0.05 $ 0.28 $ (0.36)
Diluted $ 0.17 $ 0.01 $ 0.26 $ (0.36)
Shares used in per
share computations:
Basic 12,628 1,992 11,772 1,792
Diluted 13,549 7,737 12,734 1,792
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The pro forma results are not necessarily indicative of what would have
occurred if the acquisitions had been effected for the periods presented.
In addition, they are not intended to be a projection of future results and
do not reflect any synergies that might be achieved from combined
operations.
6. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998, the FASB issued SFAS No 133 "Accounting for Derivative
Instruments and Hedging Activities". SFAS No 133 establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement
of financial position and measure those instruments at fair value. If
certain conditions are met, a derivative may be specifically designated and
accounted for as (a) a hedge of the exposure to changes in the fair value of
a recognized asset or liability or an unrecognized firm commitment, (b) a
hedge of the exposure to variable cash flows of a forecasted transaction, or
(c) a hedge of the foreign currency exposure of a net investment in a
foreign operation, an unrecognized firm commitment, an available-for-sale
security, or a foreign-currency-denominated forecasted transaction. For a
derivative not designated as a hedging instrument, changes in the fair value
of the derivative are recognized in earnings in the period of change. This
statement will be effective for all annual and interim periods beginning
after June 15, 1999 and management does not believe the adoption of SFAS No.
133 will have a material effect on the financial position of the Company.
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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. The Company'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."
OVERVIEW
SCM Microsystems designs, develops and sells standards-compliant
hardware, firmware and software products and technologies used in smart card and
other token-based network security and conditional access systems. The Company's
security and access products are targeted at OEM computer, telecommunication and
digital video broadcasting ("DVB") component and system manufacturers. The
Company markets, sells and licenses its products through a direct sales and
marketing organization primarily to OEMs and also through distributors, VARs,
system integrators and resellers worldwide.
From the Company's inception through 1994, the Company focused
primarily on PCMCIA peripheral products, including flash memory and fax/modem
devices, which carried a significantly lower gross margin than the Company's
current products. In 1994, the Company began emphasizing security and access
products. The Company made the final shipment of PCMCIA peripheral products in
the quarter ended March 31, 1997, completing its exit from this business.
The Company experiences substantial seasonality in its business, with
approximately one-third of annual net sales being realized in the first half of
the year and the remaining two-thirds being realized in the second half of the
year. In recent periods, this seasonality has been primarily the result of the
Company's reliance on sales of its SwapBox products to OEMs that in turn are
selling to U.S. government agencies. The buying pattern of U.S. government
agencies tend to be substantially weighted to the third quarter and, to a
somewhat lesser extent, the fourth quarter of the calendar year. The strength in
net sales in the third quarter which results from the U.S. government buying
patterns is somewhat offset by relatively weaker sales in Europe in the same
quarter as a result of the traditional European summer vacation patterns. The
Company expects that as sales of its DVB products, which are sold to OEMs mainly
in Europe for the consumer market, begin to represent a larger percentage of net
sales, the seasonality that the Company experiences may be further exacerbated
as such sales are likely to be strongest in the fourth quarter of the year. In
contrast to net sales, operating expenses tend to be spread relatively evenly
across the year. As a result, the Company's operating results have tended to be
weakest in first and second quarter of the year.
ACQUISITIONS
On May 19, 1998, the Company completed its acquisition of Intermart
Systems K.K.
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("Intermart") based in Tokyo, Japan. Intermart designs and sells memory card
readers and adapters used primarily in digital photography and other digital
media transfers. Total consideration paid was $8 million, with $4.9 million paid
in cash and the balance paid through the issuance of 46,551 shares of the
Company's stock. In addition, the former shareholders of Intermart can
potentially earn an additional $4 million in stock if certain performance
criteria are met during the year ended March 31, 1999.
On June 3, 1998, the Company completed its acquisition of Intellicard
Systems Pte. Ltd. ("ICS"), based in Singapore. ICS is a contract manufacturing
company that manufactures certain of the Company's products, including smart
card readers, DVB conditional access modules, and PC Card adapters. Total
consideration paid was $18.4 million, of which $14.9 million was paid in cash
and $3.5 million was paid through the issuance of 61,185 shares of the Company's
stock. Approximately $11.4 million of the cash portion of the consideration was
paid in exchange for cash and a $2.0 million shareholder note held by ICS at the
closing of the transaction. The note was repaid by the shareholder prior to June
30, 1998.
The acquisitions of Intermart and ICS were both accounted for pursuant
to the purchase method of accounting. Accordingly, the historical financial
statements of the Company exclude the assets and liabilities, results of
operation and cash flows of Intermart and ICS for all periods ending at or prior
to the respective dates of acquisition. The assets and liabilities of Intermart
and ICS were recorded at their fair values at the respective acquisition dates.
The aggregate fair value of Intermart's and ICS' research and development
efforts that had not reached technological feasibility as of the respective
dates of acquisition and had no alternative future uses was determined by
appraisal to be $5.9 million, and was expensed at the respective dates of the
acquisitions.
The following discussion of the Company's results of operations for the
quarter and six months ended June 30, 1998 reflect the results of SCM
Microsystems, Inc. for the entire periods, together with the results of
Intermart and ICS from their respective dates of acquisition.
RESULTS OF OPERATIONS
Net Sales. Net sales reflect the invoiced amount for goods shipped less
estimated returns. Revenue is recognized upon product shipment. Net sales for
the quarter ended June 30, 1998 were $10.6 million compared to $5.6 million in
the second quarter of 1997, an increase of 89%. For the first six months of
1998, net sales were $18.4 million compared to $10.0 million in the first six
months of 1997, an increase of 84%. The increase in the second quarter and in
the first six months of 1998 was primarily due to an increase in shipments of
DVB-CAM products and services in Europe, and an increase in SwapBox revenues in
the U.S., primarily to OEM customers supplying U.S. government agencies. In
addition, the first volume shipments of the Company's SwapSmart readers in the
U.S. took place in the second quarter.
Gross Profit. Gross profit for the second quarter of 1998 was $4.2
million, or 39% of total net sales, compared to $2.3 million, or 41% of total
net sales for the second quarter of 1997. Gross profit for the first six months
of 1998 was $7.1 million, or 38% of total net sales, compared to $3.9 million or
39% in the first six months of 1997. The increases in gross profit in
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absolute amounts for both the second quarter and first six months of 1998 were
primarily due to the aforementioned increases in revenue. The Company believes
that its gross profit in absolute dollars during 1998 will continue to be above
the levels experienced in 1997. The Company's 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, all of which tend to carry higher gross profit than older
products, 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, the Company has not capitalized any software
development costs. Research and development expenses for the second quarter of
1998 were $857,000, compared with $790,000 in the second quarter of 1997, an
increase of 8%. As a percentage of total net sales, research and development
expenses were 8% and 14% in the second quarter of 1998 and 1997, respectively.
For the first six months of 1998, research and development expenses were $1.6
million, compared with $1.4 million in the comparable period of 1997, an
increase of 14%. As a percentage of total net sales, research and development
expenses were 9% in the first six months 1998 compared to 14% for the comparable
period in 1997. The increases in absolute amounts for the second quarter and
first six months of 1998 were primarily due to engineering headcount and related
product development costs of the acquired companies. The Company believes that
the absolute amount of research and development expenses during the remainder of
1998 will be higher than the last two quarters of 1997 due to a higher number of
personnel involved in the Company's new product development and customer
projects, but that such expenses will fluctuate as a percentage of total net
sales.
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 second quarter of 1998 were $1.2 million, compared
with $1.0 million in the second quarter of 1997, an increase of 14%. As a
percentage of total net sales, these expenses were 11% in the second quarter of
1998, compared with 18% in the comparable period of 1997. For the first six
months of 1998, sales and marketing expenses were $2.2 million, compared with
$2.0 million in the comparable period of 1997, an increase of 11%. These
increases in absolute amounts in 1998 were primarily due to sales and marketing
costs of the acquired companies. The decrease in sales and marketing expenses as
a percentage of total net sales in the second quarter and first six months of
1998 compared to the comparable periods of 1997 was due to a cost structure in
sales and marketing consisting primarily of fixed expenses that have increased
at a slower pace than the Company's revenue growth. Sales and marketing expenses
in the remainder of 1998 are expected to increase in absolute amounts as the
Company continues to expand its sales and business development efforts on a
worldwide basis
General and Administrative. General and administrative expenses consist
primarily of compensation expenses for employees performing the Company's
administrative functions. General and administrative expenses were $1.4 million
in the second quarter of 1998, or 13% of total net sales, compared with
$585,000, or 10% of total net sales in the second quarter of 1997,
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an increase of 143%. For the six month period, general and administrative
expenses were $2.2 million in 1998, an increase of 94% compared with $1.1
million in 1997, representing 12% and 11% of total net sales in the six months
period in 1998 and 1997, respectively. These increases in absolute amounts were
primarily due to increases in administrative headcount in the Company's U.S. and
Pfaffenhofen, Germany offices to support higher levels of business activities,
increased costs relating to the Company operating as a public company subsequent
to its IPO in October 1997, and administrative costs of the acquired businesses.
The Company believes general and administrative expenses in the remainder of
1998 will continue to increase in absolute amount for all of the aforementioned
reasons, but will fluctuate as a percentage of total net sales.
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. In the second quarter of 1998, net interest income was $1.7
million, compared to net interest income of $261,000 in the second quarter of
1997. In the first six months of 1998, interest income and other, net, was $2.4
million, compared to $297,000 in the comparable period of 1997. In April 1998,
the Company completed a secondary offering of 3.45 million shares of its common
stock (2.0 million shares sold by selling stockholders and 1.45 million shares
sold by the Company), which generated net proceeds to the Company of
approximately $83 million. Investment of the net proceeds will generate future
net investment income in the remainder of 1998 at levels higher than experienced
in 1997.
Income Taxes. A provision for income taxes of $620,000 was booked in
the second quarter of 1998, an effective tax rate of 26%, net of in-process
research and development and other acquisition costs, resulting principally from
tax liabilities associated with foreign operations of the Company and minimum
state income taxes. As of December 31, 1997, the Company had German net
operating loss carry forwards of approximately $1.4 million available for an
indefinite period to offset income from the Company's German operations. In
addition, the Company had net operating loss carry forwards of approximately
$3.3 million and $1.6 million for United States federal and California income
tax purposes, respectively. The Company's utilization of United States federal
operating loss carry forwards is limited to approximately $340,000 per year.
LIQUIDITY AND CAPITAL RESOURCES
Prior to the Company's initial public stock offering, the Company had
financed its operations principally through private placements of debt and
equity securities and, to a lesser extent, borrowings under bank lines of
credit. In October 1997, the Company completed the sale of 3.8 million shares of
Common Stock in an initial public offering ("IPO"), resulting in net proceeds of
$43.7 million. In April 1998, the Company completed a secondary offering of 3.45
million shares of its Common Stock at a price to the public of $61.00 per share.
Of the total number of shares sold, 2.0 million shares were sold by shareholders
and 1.45 million shares were sold by the Company. The net proceeds to the
Company from the secondary offering were $83.1 million.
As of June 30, 1998, the Company's working capital was $143.4 million,
compared to a working capital of $60.3 million as of December 31, 1997. Working
capital increased in the first
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six months of 1998 due primarily to the net proceeds from the follow-on offering
of $83.1 million and the Company's receipt of $6.3 million in net proceeds from
the exercise of warrants and options, partially offset by working capital used
in operations, capital expenditures, and the acquisitions of Intermart and ICS.
During the first six months of 1998, cash and cash equivalents
increased by $17.8 million due primarily to net proceeds of $89.4 million from
the issuance of common stock and $16.5 million proceeds from maturities of
short-term investments, partially offset by $75.3 million used to purchase
short-term investments, $404,000 used for capital expenditures, $9.9 million for
the businesses acquired, net of cash received, and $2.1 million used in
operations. Cash was used in operations primarily for an increase in accounts
receivable of $2.8 million due primarily to higher revenue, partially offset by
increases in accrued expenses and income taxes.
The Company has revolving lines of credit with three banks in Germany
providing total borrowings of up to 1.5 million DM each (approximately $2.5
million in total at June 30, 1998). Two of these lines of credit expire on
September 30, 1998 and the third has no fixed expiration date. The German lines
of credit bear interest at rates ranging from 7.0% to 8.75%. Borrowings under
the German lines of credit are unsecured. The Company also has a $3.0 million
U.S. line of credit which is secured by all assets of the Company, bears
interest at the bank's prime rate, and expires in May 1999. At June 30, 1998, no
amounts were outstanding under any of the Company's lines of credit.
The Company presently expects that its current capital resources and
available borrowings should be sufficient to meet its operating and capital
requirements through at least the end of 2000. The Company may, however, seek
additional debt or equity financing prior to that time. There can be no
assurance that additional capital will be available to the Company on favorable
terms or at all. The sale of additional debt or equity securities may cause
dilution to existing stockholders.
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FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
HISTORY OF OPERATING LOSSES; POTENTIAL FLUCTUATIONS IN QUARTERLY
RESULTS; SEASONALITY
Although the Company was profitable for each of the four fiscal
quarters ended June 30, 1998 (before interest accretion on preferred stock and
non-recurring adjustments), the Company incurred a net loss of $410,000 (before
interest accretion on preferred stock and non-recurring adjustments) for the six
months ended June 30, 1997 and net operating losses on an annual basis from its
inception in 1993 through the year ended December 31, 1996. As of June 30, 1998,
the Company had an accumulated deficit of $11.7 million. In view of the
Company's loss history, there can be no assurance that the Company will be able
to achieve or sustain profitability on an annual or quarterly basis in the
future.
The Company's quarterly operating results have in the past varied and
may in the future vary significantly. Factors affecting operating results
include: the level of competition; the size, timing, cancellation or
rescheduling of significant orders; market acceptance of new products and
product enhancements; new product announcements or introductions by the Company
or its competitors; adoption of new technologies and standards; changes in
pricing by the Company or its competitors; the ability of the Company to
develop, introduce and market new products and product enhancements on a timely
basis, if at all; hardware component costs and availability, particularly with
respect to hardware components obtained from sole or limited source suppliers;
the Company's success in expanding its sales and marketing organization and
programs; technological changes in the market for digital information security
products; levels of expenditures on research and development; foreign currency
exchange rates; and general economic trends. In addition, because a high
percentage of the Company's operating expenses are fixed, a small variation in
revenue can cause significant variations in operating results from quarter to
quarter.
The Company has experienced significant seasonality in its business,
and the Company's business and operating results are likely to be affected by
seasonality in the future. The Company has typically experienced higher net
sales in the third quarter and fourth quarter of each calendar year followed by
lower net sales and operating income in the first quarter and second quarter of
the following year. The Company believes that this trend has been principally
due to budgeting requirements of the U.S. government which influence the
purchasing patterns of OEMs which supply PCs and workstations incorporating the
Company's data security products to the U.S. government. The Company expects
that as sales of its DVB products, which are currently sold to OEMs mainly in
Europe for the consumer market, begin to represent a larger percentage of net
sales, the seasonality that the Company experiences may be further exacerbated
as these sales are likely to be strongest in the fourth quarter of the year.
Initial sales of the Company's products to a new customer typically
involve a sales cycle which can range from six to nine months during which the
Company may expend substantial financial resources and management time and
effort with no assurance that a sale will ultimately result. The length of the
sales cycle may vary depending on a number of factors over which the Company may
have little or no control, including product and technical requirements, and the
level of competition which the Company encounters in its selling activities. Any
delays in the
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sales cycle for new customers could have a material adverse effect on the
Company's business and operating results.
Based upon the factors enumerated above, the Company believes that its
operating results may vary significantly in future periods and that historical
results are not reliable indicators of future performance. It is likely that, in
some future quarter or quarters, the Company's operating results will be below
the expectations of stock market analysts and investors. In such event, the
market price of the Company's Common Stock could decline significantly.
DEPENDENCE ON EMERGING PRODUCT MARKETS; UNCERTAINTY OF MARKET
ACCEPTANCE OF THE COMPANY'S PRODUCTS
From the Company's inception through 1994, the Company focused on PCMCIA
peripheral products, including flash memory and fax/modem devices. In 1994, the
Company began emphasizing security and access products. The Company made the
final shipment of PCMCIA peripheral products in the quarter ended June 30, 1997,
completing its exit from this business. As a result of the Company's strategic
shift in product focus, the proportion of security and access product sales
increased from 22.1% of total net sales in 1994 to 99.4% of total net sales in
1997, and to 100% of total net sales in the second quarter of 1998. The
Company's net sales are now and will continue to be dependent upon the success
of its security and access products.
The Company's future growth and operating results will depend to a large
extent on the successful marketing and commercial viability of the Company's
security and access product families. Each of these product families addresses
needs in different emerging markets. Smart card token-based security
applications are able to provide protection from unauthorized access to digital
information. The Company believes that smart cards are ideally suited to serve
as tokens for network and electronic commerce security. Accordingly, the
Company's SwapBox and SwapSmart product families are designed to provide smart
card token-based security for PCs. However, there can be no assurance that the
smart card will become the industry standard for network and electronic commerce
security applications. The Company's DVB product family provides a means of
controlling access to digital television broadcasts. The Company's SwapAccess
DVB-CAM product implements the DVB-CI and NRSS-B standards. To date, the
Company's DVB-CAM product has been implemented in a relatively limited number of
DVB set-top boxes in Europe. Although the Company believes that the DVB-CI
standard will eventually become the European standard for DVB conditional access
applications, there can be no assurance that the standard will be adopted, that
the European DVB market will further develop or that even if such standard is
adopted and the market further develops, the Company's DVB-CAM products will be
widely adopted. Furthermore, the market for DVB products in the United States
has only recently begun to develop. There can be no assurance whether, or to
what extent, the United States DVB market will grow. In addition, the
substantial installed base of analog set-top boxes in the United States may
cause the market for DVB products in general, and the Company's SwapAccess
products in particular, to grow slower than expected, if at all.
If the market for the products described above or any of the Company's
other products fails to develop or develops more slowly than expected or if any
of the standards supported by the Company do not achieve or sustain market
acceptance, the Company's business and operating results would be materially and
adversely affected.
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DEPENDENCE ON SALES TO OEMs
A substantial majority of the Company's products are intended for use
as components or subsystems in systems manufactured and sold by third party
OEMs. In 1997, almost all of the Company's sales were to OEMs and the Company
expects this dependence on OEM sales to continue. In 1997, sales to BetaDigital
(a division of the Kirch Group) accounted for 45% of total net sales and sales
to the Company's top 10 customers (all of which are OEMs) accounted for 80% of
total net sales. In the first six months of 1998, sales to BetaDigital accounted
for 28% of total net sales, sales to Telenor Conax A.S. and subsidiaries
accounted for 20% of total net sales, and sales to the Company's top 10
customers (9 of which are OEMs) accounted for 67% of total net sales. In order
for an OEM to incorporate the Company's products into its systems, the Company
must demonstrate that its products provide significant commercial advantages to
OEMs over competing products. There can be no assurance that the Company can
successfully demonstrate such advantages or that the Company's products will
continue to provide any advantages. Moreover, even if the Company is able to
demonstrate such advantages, there can be no assurance that OEMs will elect to
incorporate the Company's products into their current or future systems.
Further, the business strategies and manufacturing practices of the Company's
OEM customers are subject to change and any such change may result in decisions
by the customers to decrease their purchases of the Company's products, seek
other sources for products currently manufactured by the Company or manufacture
these products internally. The Company's OEM customers may also seek price
concessions from the Company. Failure of OEMs to incorporate the Company's
products into their systems, the failure of such OEMs' systems to achieve market
acceptance or any other event causing a decline in the Company's sales to OEMs
would have a material adverse effect on the Company's business and operating
results.
DEPENDENCE ON SALES TO GOVERNMENT CONTRACTORS
Approximately 51%, 39%, 28% and 18% of the Company's net sales during
1995, 1996, 1997 and the first six months of 1998, respectively, were derived
from sales of the Company's SwapBox product for use by the U.S. government, all
of which were made under contracts between the Company and major OEMs that sell
PCs to the United States Department of Defense (the "DoD"). The Company believes
that indirect sales to the DoD are subject to a number of significant
uncertainties, including timing and availability of funding, unforeseen changes
in the timing and quantity of government orders and the competitive nature of
government contracting generally. Furthermore, the DoD has been reducing total
expenditures over the past few years in a number of areas and there can be no
assurance that such funding will not be reduced in the future. In addition,
there is no assurance that the Company will 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 the Company's business and
operating results.
DEPENDENCE ON DEVELOPMENT OF INDUSTRY RELATIONSHIPS
The Company is party to collaborative arrangements with a number of
corporations and is a member of key industry consortia. The Company has formed
strategic relationships, including technology sharing agreements, with a number
of key industry players such as Intel, Gemplus and
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Telenor. The Company evaluates, on an ongoing basis, potential strategic
alliances and intends to continue to pursue such relationships. The Company's
future success will depend significantly on the success of its current
arrangements and its ability to establish additional arrangements. There can be
no assurance that these arrangements will result in commercially successful
products.
COMPETITION
The market for digital data security and access control products is
intensely competitive and characterized by rapidly changing technology. The
Company believes that competition in this market is likely to intensify as a
result of increasing demand for security products. The Company currently
experiences competition from a number of sources, including: (i) ActionTec,
Carry Computer Engineering, Greystone and Litronic in PC Card adapters; (ii)
SmartDisk Corporation, Philips and Tritheim in smart card readers and universal
smart card reader interfaces; and (iii) Gemplus in DVB-CAM modules. The Company
also experiences indirect competition from certain of its customers which
currently offer alternative products or are expected to introduce competitive
products in the future. The Company may in the future face competition from
these and other parties including new entrants, such as Motorola, that develop
digital information security products based upon approaches similar to or
different from those employed by the Company. In addition, there can be no
assurance that the market for digital data security and access control products
will not ultimately be dominated by approaches other than the approach marketed
by the Company.
Many of the Company's current and potential competitors have
significantly greater financial, technical, marketing, purchasing and other
resources than the Company, and as a result, may be able to respond more quickly
to new or emerging technologies or standards and to changes in customer
requirements, or may be able to devote greater resources to the development,
promotion and sale of products, or 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 the Company's
prospective customers. Accordingly, 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 which could have a material
adverse effect on the Company's business and operating results.
The Company believes that the principal competitive factors affecting the
market for digital data security products include: the extent to which products
support industry standards and provide interoperability; technical features;
ease of use; quality/reliability; level of security; strength of distribution
channels; and price. There can be no assurance that the Company will be able to
compete as to these or other factors or that competitive pressures faced by the
Company will not materially and adversely affect its business and operating
results.
MANAGEMENT OF GROWTH
The Company's business has grown substantially in recent periods, with net
sales increasing from $6.4 million in 1994 to $27.8 million in 1997. The growth
of the Company's business has placed a significant strain on the Company's
management and operations. In addition, a number
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of key members of the Company's management, including its President and Chief
Executive Officer, Chief Financial Officer and Vice President-Operations have
joined the Company within the past two years. Furthermore, in 1993 the Company
commenced operations in North America which included the establishment of a U.S.
management team. As a result, the Company has a limited operating history under
its current U.S. management. In addition, the number of employees has increased
from 50 at December 31, 1995 to 151 as of June 30, 1998. If the Company is
successful in achieving its growth plans, such growth is likely to place a
significant burden on the Company's operating and financial systems, resulting
in increased responsibility for senior management and other personnel within the
Company. There can be no assurance that the Company's existing management or any
new members of management will be able to augment or improve existing systems
and controls or implement new systems and controls in response to anticipated
future growth. The Company's failure to do so could have a material adverse
effect on the Company's business and operating results.
INTEGRATION OF GLOBAL LOCATIONS
The Company's U.S. headquarters are located in Los Gatos, California, its
European headquarters are located in Pfaffenhofen, Germany, and its research and
development facilities are located in Erfurt, Germany and La Ciotat, France. In
Asia, the Company is located in Singapore and in Tokyo, Japan. Operating in
diverse geographic locations imposes a number of risks and burdens on the
Company, 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 the Company seeks
to mitigate the difficulties associated with operating in diverse geographic
locations through the extensive use of electronic mail and teleconferencing,
there can be no assurance that it will not encounter unforeseen difficulties or
logistical barriers in operating in diverse locations. Furthermore, operations
in widespread geographic locations require the Company to implement and operate
complex information systems that are capable of providing timely information
which can readily be consolidated. Although the Company believes that its
information systems are adequate, the Company may in the future have to
implement new information systems. Implementation of such new information
systems may be costly and may require training of personnel. Any failure or
delay in implementing these systems, procedures and controls on a timely basis,
if necessary, or in expanding these areas in an efficient manner at a pace
consistent with the Company's business could have a material adverse effect on
the Company's business and operating results.
PROPRIETARY TECHNOLOGY AND INTELLECTUAL PROPERTY
The Company's success depends significantly upon its proprietary
technology. The Company currently relies on a combination of patent, copyright
and trademark laws, trade secrets, confidentiality agreements and contractual
provisions to protect its proprietary rights. The Company seeks to protect its
software, documentation and other written materials under trade secret and
copyright laws, which afford only limited protection. The Company generally
enters into confidentiality and non-disclosure agreements with its employees and
with key vendors and suppliers. The Company's SwapBox trademark is registered in
the United States, and the SwapSmart trademark is the subject of an allowed,
pending application. The Company will continue to evaluate the registration of
additional trademarks as appropriate. The Company currently has one U.S. patent
issued, six U.S., one French and one Japanese patent applications
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pending, and exclusive licenses under four other U.S. patents associated with
its products. Furthermore, the Company intends to obtain an exclusive license
from one of its employees to five other patents relating to its products. There
can be no assurance that any new patents will be issued, that the Company will
develop proprietary products or technologies that are patentable, that any
issued patent will provide the Company with any competitive advantages or will
not be challenged by third parties, or that the patents of others will not have
a material adverse effect on the Company's business.
There has also been substantial litigation in the technology industry
regarding intellectual property rights, and litigation may be necessary to
protect the Company's proprietary technology. The Company has from time to time
received claims that it is infringing upon third parties' intellectual property
rights, and there can be no assurance that third parties will not in the future
claim infringement by the Company with respect to current or future products,
patents, trademarks or other proprietary rights. In April 1997, Gemplus served
the Company with a complaint alleging that the Company's SwapSmart product
infringes certain claims of a French patent held by Gemplus. Although such
dispute was settled on terms acceptable to the Company, there can be no
assurance that future disputes with third parties will not arise nor that any
such disputes can be resolved on terms acceptable to the Company. The Company
expects that companies in the computer and digital information security market
will increasingly be subject to infringement claims as the number of products
and competitors in the Company's target markets grows. Any such claims or
litigation may be time-consuming and costly, cause product shipment delays,
require the Company to redesign its products or require the Company to enter
into royalty or licensing agreements, any of which could have a material adverse
effect on the Company's business and operating results. Despite the Company's
efforts to protect its proprietary rights, unauthorized parties may attempt to
copy aspects of the Company's products or to obtain and use information and
software that the Company regards as proprietary. 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. There can be no
assurance that the Company's means of protecting its proprietary and
intellectual property rights will be adequate or that the Company's competitors
will not independently develop similar technology, duplicate the Company's
products or design around patents issued to the Company or other intellectual
property rights of the Company.
DEPENDENCE ON CONTRACT AND OFFSHORE MANUFACTURING; LIMITED
NUMBER OF SUPPLIERS OF KEY COMPONENTS
The Company has implemented a global sourcing strategy that it believes
will enable it to achieve greater economies of scale, improve gross margins and
maintain uniform quality standards for its products. The majority of the
Company's products are now manufactured by its wholly-owned subsidiary in
Singapore, Intellicard, which was acquired in June 1998. In addition, the
Company currently sources some of its products through two contract
manufacturers in Europe. In the event the Company exceeds current capacity
levels at Intellicard and any of the Company's outside contract manufacturers
are unable or unwilling to continue to manufacture the Company's products, the
Company may have to rely on other current manufacturing sources or identify and
qualify new contract manufacturers. In this regard, one of the Company's
contract manufacturers has recently been involved in bankruptcy proceedings and
may be unable to continue manufacturing the Company's products. In the event
that such manufacturer (or any
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other key supplier) were unable to meet the Company's requirements, there can be
no assurance that the Company would be able to identify or qualify new contract
manufacturers in a timely manner or that such manufacturers would allocate
sufficient capacity to the Company in order to meet its requirements. Any
significant delay in the Company's ability to obtain adequate supplies of its
products from its current or alternative sources would materially and adversely
affect the Company's business and operating results.
In an effort to reduce manufacturing costs, the Company has shifted
volume production of many components of its products to Singapore. The Company
is currently considering shifting the production of other components of its
products to other suppliers in Europe or Asia. Difficulties encountered in
transferring production may have a disruptive effect on the Company's
manufacturing process and increase overall production costs. Foreign
manufacturing is subject to 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.
The Company relies upon a limited number of suppliers of several key
components utilized in the assembly of the Company's products. For example, the
Company purchases mechanical components for use in its smart card reader product
exclusively from Stocko, a German-based supplier. The Company's reliance on sole
source suppliers involves several risks, including a potential inability to
obtain an adequate supply of required components, price increases, late
deliveries and poor component quality. Although to date the Company has been
able to purchase its requirements of such components, there can be no assurance
that the Company will be able to obtain its full requirements of such components
in the future or that prices of such components will not increase. In addition,
there can be no assurance that problems with respect to yield and quality of
such components and timeliness of deliveries will not occur. Disruption or
termination of the supply of these components could delay shipments of the
Company's products and could have a material adverse effect on the Company's
business and operating results. Such delays could also damage relationships with
current and prospective customers.
DEPENDENCE ON NEW PRODUCTS; RAPID TECHNOLOGICAL CHANGE
The markets for the Company's products are characterized by rapid
technological change, changing customer needs, frequent new product introduction
and evolving industry standards and short product lifecycles. The introduction
by the Company or its competitors of products embodying new technologies and the
emergence of new industry standards could render the Company's existing products
obsolete and unmarketable. Therefore, the Company's future success will depend
upon its ability to successfully develop and to introduce on a timely and
continuous basis new and enhanced products that keep pace with technological
developments and emerging industry standards and address the increasingly
sophisticated needs of its customers. The timing and success of product
development is unpredictable due to the inherent uncertainty in anticipating
technological developments, the need for coordinated efforts of numerous
technical personnel and the difficulties in identifying and eliminating design
flaws prior to product release. Any significant delay in releasing new products
could have a material adverse effect on the ultimate success of a product and
other related products and could impede continued sales of predecessor products,
any of which could have a material adverse effect on the
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Company's business and operating results. There can be no assurance that the
Company will be able to introduce new products on a timely basis, that new
products introduced by the Company will achieve any significant degree of market
acceptance or that any such acceptance will be sustained for any significant
period. Failure of new products to achieve or sustain market acceptance could
have a material adverse effect on the Company's business and operating results.
RISKS OF INTERNATIONAL SALES; CURRENCY FLUCTUATIONS
The Company was originally a German corporation and continues to
conduct a substantial portion of its business in Europe. Approximately 49%, 53%,
69% and 62% of the Company's revenues in 1995, 1996, 1997, and the first six
months of 1998, respectively, were derived from customers located outside the
United States. Because a significant number of the Company's principal customers
are located in other countries, the Company anticipates that international sales
will continue to account for a significant portion of its revenues. As a result,
a significant portion of the Company's sales and operations may continue to be
subject to certain risks, including tariffs and other trade barriers,
difficulties in staffing and managing disparate branch operations, currency
exchange risks and exchange controls and potential adverse tax consequences.
These factors may have a material adverse effect on the Company's business and
operating results.
As a result of the Company's multinational operations and sales, and
particularly since the Company's recent business acquisitions in Japan and
Singapore, the Company's operating results are subject to significant
fluctuations based upon changes in the exchange rates of certain currencies,
particularly the German mark, the Japanese yen and the Singapore dollar, in
relation to the U.S. dollar. The Company does not currently engage in hedging
activities with respect to its foreign currency exposure. Although management
will continue to monitor the Company's exposure to currency fluctuations, and,
when appropriate, may use financial hedging techniques in the future to minimize
the effect of these fluctuations, there can be no assurance that exchange rate
fluctuations will not have a material adverse effect on the Company's business
and operating results. In the future, the Company could be required to
denominate its product sales in other currencies, which would make the
management of currency fluctuations more difficult and expose the Company to
greater risks in this regard.
PRODUCT LIABILITY RISKS
Customers rely on the Company's token-based security products to
prevent unauthorized access to their digital content. A malfunction of or design
defect in the Company's products could result in tort or warranty claims.
Although the Company attempts to reduce the risk of exposure from such claims
through warranty disclaimers and liability limitation clauses in its sales
agreements and by maintaining product liability insurance, there can be no
assurance that such measures will be effective in limiting the Company's
liability for any such damages. Any liability for damages resulting from
security breaches could be substantial and could have a material adverse effect
on the Company's business and operating results. In addition, a well-publicized
actual or perceived security breach involving token-based security systems could
adversely affect the market's perception of token-based security products in
general, or the Company's products in particular, regardless of whether such
breach is attributable to the Company's products. This could result in a decline
in demand for the Company's products, which would have a material
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adverse effect on the Company's business and operating results.
YEAR 2000 COMPLIANCE
Many currently installed computer systems and software products are
coded to accept only two digit in the date code field. These data code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, many companies' software and computer systems
may need to be upgraded or replaced in order to comply with such "Year 2000"
requirements. Although the Company believes that its products and systems are
Year 2000 compliant, the Company utilizes third-party equipment or software that
may not be Year 2000 compliant. Failure of such third-party equipment or
software to operate properly with regard to the Year 2000 and thereafter could
require the Company to incur unanticipated expenses to remedy any problems,
which could have a material adverse effect on the Company's business and
operating results. Furthermore, the purchasing patterns of customers or
potential customers may be affected by Year 2000 issues as companies expend
significant resources to correct their current systems for Year 2000 compliance.
These expenditures may result in reduced funds available to purchase products
and services such as those offered by the Company, which could have a material
adverse effect on the Company's business and operating results.
DEPENDENCE ON KEY PERSONNEL; ABILITY TO RECRUIT PERSONNEL
The Company's future performance depends in significant part upon the
continued service of Robert Schneider, the Company's Chairman of the Board,
Steven Humphreys, the Company's President and Chief Executive Officer, and Bernd
Meier, the Company's Chief Operating Officer, as well as its other key technical
and senior management personnel. The Company 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,
the Company's 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 six months notice, and provides that the officer is bound by a
non-compete provision during the one-year period following his termination.
Non-compete agreements are, however, generally difficult to enforce and
therefore these provisions may not provide significant protection to the
Company. The Company also has an employment agreement with Jean-Yves Le Roux,
its Vice President, Engineering, that is terminable by either party at will. The
Company does not have employment agreements with any of its other key employees
and does not maintain key man life insurance on any of its employees. The loss
of the services of one or more of the Company's officers or other key employees
could have a material adverse effect on the Company's business and operating
results. The Company believes that its future success will depend in large part
on its continuing ability to attract and retain highly qualified technical and
management personnel. Competition for such personnel is intense, and there can
be no assurance that the Company can retain its key technical and management
employees or that it can attract, assimilate or retain other highly qualified
technical and management personnel in the future.
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