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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
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
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)
47211 BAYSIDE PARKWAY, FREMONT, CA 94538
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE)
(510) 360-2300
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
N/A
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
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, 2001, 15,326,349 shares of common stock were outstanding.
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ITEM 1. FINANCIAL STATEMENTS
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
THREE MONTHS ENDED MARCH 31,
----------------------------
2001 2000
---------- --------
Net revenue $ 45,107 $ 32,072
Cost of revenue 40,863 20,106
-------- --------
Gross profit 4,244 11,966
-------- --------
Operating expenses:
Research and development 3,582 2,721
Selling and marketing 8,576 3,871
General and administrative 6,193 2,586
Amortization of goodwill and intangibles 3,708 434
In-process research and development 115 -
-------- --------
Total operating expenses 22,174 9,612
-------- --------
Income (loss) from operations (17,930) 2,354
Loss from investments (5,679) -
Interest and other, net (33) 1,782
-------- --------
Income (loss) before income taxes and minority
interest (23,642) 4,136
Benefit (provision) for income taxes 5,188 (1,241)
Minority interest in loss (earnings) of consolidated
subsidiaries 100 (217)
-------- --------
Net income (loss) $(18,354) $ 2,678
======== ========
Basic net income (loss) per share $ (1.20) $ 0.19
======== ========
Diluted net income (loss) per share $ (1.20) $ 0.17
======== ========
Shares used to compute basic net income (loss) per share 15,269 14,275
======== ========
Shares used to compute diluted net income (loss) per share 15,269 15,669
======== ========
Comprehensive income (loss):
Net income (loss) $(18,354) $ 2,678
Unrealized gain on investment net of deferred taxes 1,049 622
Foreign currency translation adjustment (2,442) (275)
-------- --------
Total comprehensive income (loss) $(19,747) $ 3,025
======== ========
See notes to condensed consolidated financial statements.
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SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
MARCH 31, DECEMBER 31,
ASSETS 2001 2000
--------- ------------
Current assets:
Cash, cash equivalents and short-term investments $ 51,757 $ 66,926
Accounts receivable, net 48,984 54,913
Inventories 34,623 36,799
Other current assets 7,808 5,492
--------- ---------
Total current assets 143,172 164,130
Property and equipment, net 10,349 10,476
Investments 4,041 8,070
Long-term deferred income taxes 10,286 5,086
Intangible assets, net 62,346 64,129
Other assets 1,376 504
--------- ---------
Total assets $ 231,570 $ 252,395
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 29,665 $ 27,167
Accrued expenses 8,005 12,071
Income taxes payable 843 1,147
--------- ---------
Total current liabilities 38,513 40,385
Deferred tax liability 2,133 1,214
Minority interest 159 636
Stockholders' equity:
Capital stock 15 15
Additional paid-in capital 222,627 223,677
Deferred stock compensation (2,599) (4,001)
Accumulated deficit (24,415) (6,061)
Other cumulative comprehensive income (4,863) (3,470)
--------- ---------
Total stockholders' equity 190,765 210,160
--------- ---------
Total liabilities and
stockholders' equity $ 231,570 $ 252,395
========= =========
See notes to condensed consolidated financial statements.
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SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
THREE MONTHS
ENDED MARCH 31,
-----------------------------
2001 2000
-------- --------
Cash flows from operating activities:
Net income (loss) $(18,354) $ 2,678
Adjustments to reconcile net income (loss) to net
cash used in operating activities:
Deferred income taxes (5,200) 169
Depreciation and amortization 4,453 1,025
In-process research and development 115 --
Minority interest in earnings of subsidiaries (100) 217
Amortization of deferred stock compensation 192 17
Loss on long-term investments 5,679 --
Changes in operating assets and liabilities:
Accounts receivable 4,100 (431)
Inventories 826 (4,192)
Other assets (1,967) 1,006
Accounts payable 3,191 (2,039)
Accrued expenses (3,769) (1,030)
Income taxes payable (257) (996)
-------- --------
Net cash used in operating activities (11,091) (3,576)
-------- --------
Cash flows provided by (used in) investing activities:
Capital expenditures (2,109) (954)
Purchase of long-term investment -- (2,000)
Business acquired, net of cash received (2,366) --
Maturities of short-term investments 26,580 34,222
Purchases of short-term investments (25,460) (15,348)
-------- --------
Net cash provided by (used in) investing activities (3,355) 15,920
-------- --------
Cash flows from financing activities:
Payments on line of credit and other current debt -- (28)
Proceeds from issuance of equity securities, net 153 7,591
-------- --------
Net cash provided by financing activities 153 7,563
Effect of exchange rates on cash and cash equivalents 204 255
-------- --------
Net increase (decrease) in cash and cash equivalents (14,089) 20,162
Cash and cash equivalents at beginning of period 33,699 45,662
-------- --------
Cash and cash equivalents at end of period $ 19,610 $ 65,824
======== ========
Supplemental disclosures of cash flow information:
Cash paid for income taxes $ 389 $ 3,029
======== ========
Cash paid for interest $ -- $ 21
======== ========
See notes to condensed consolidated financial statements.
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SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America 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 accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for a fair presentation
have been included. Operating results for the three-month period ended March 31,
2001 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2001. For further information, refer to the financial
statements and footnotes thereto included in SCM Microsystems' ("SCM") December
31, 2000 annual report on Form 10-K.
2. LONG-TERM INVESTMENTS
Long-term investments consist of the following (in thousands):
MARCH 31, DECEMBER 31,
2001 2000
--------- ------------
Investment in SmartDisk, at fair value ............. $ 948 $1,306
Investment in Spyrus, at estimated value ........... 809 4,046
Investment in ActivCard, at fair value ............. 1,274 1,551
Investment in SATUP, at cost ....................... 859 859
Other .............................................. 151 308
------ ------
Total ...................................... $4,041 $8,070
====== ======
The investments in SmartDisk and ActivCard represent the quoted market
value of SCM's investment in their common stock.
In 1999, SCM made loans to Spyrus, a privately held company which
provides Internet identification and encryption solutions for e-business. In
March 2000, SCM converted its loans into shares of Spyrus' Series B convertible
preferred stock. In the fourth quarter of 2000, SCM invested an additional $0.5
million in Spyrus Series B convertible preferred stock. This additional
investment brought SCM's ownership of all outstanding shares of Spyrus to
approximately 16.4%.
In September 2000, SCM loaned $0.8 million to Satup Databroadcasting AG
("Satup"), a privately held satellite content distributor located in Weinstadt,
Germany. In the fourth quarter of 2000, the loan was converted into common
shares of Satup and an additional $0.1 million was invested into common shares
to bring SCM's ownership in Satup to approximately 10%. Satup is a customer of
SCM.
During each quarter, we evaluate the above investments for possible
asset impairment. We examine a number of factors including the current economic
conditions and markets for each investment, as well as their cash position and
anticipated cash needs for the short- and long-term. During the first quarter of
2001, because of the persistent deterioration of general economic conditions,
changes in specific market conditions for each investment and difficulties
involved by these companies in obtaining addition funding, SCM determined that
our investments in SmartDisk and Spyrus have been permanently impaired.
Accordingly, we wrote down our investment in SmartDisk to its fair market value
as of March 31, 2001 and wrote down our investment in Spyrus to its estimated
value which
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approximated 20% of the original cost. The result was a charge to the income
statement of $5.7 million in the first quarter of 2001.
3. INVENTORIES
Inventories consist of (in thousands):
AS OF AS OF
MARCH 31, DECEMBER 31,
2001 2000
--------- ------------
Raw materials ................ $14,581 $20,599
Finished goods ............... 20,042 16,200
------- -------
$34,623 $36,799
======= =======
4. RECENT ACCOUNTING PRONOUNCEMENT
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, is effective for all fiscal years beginning after June 15, 2000.
SFAS No. 133, as amended establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. Under SFAS No. 133, certain
contracts that were not formerly considered derivatives may now meet the
definition of a derivative. The Company adopted SFAS No. 133 effective January
1, 2001. The Company generally does not utilize derivative instruments and had
no such instruments at January 1, 2001, therefore, the adoption of SFAS No. 133
in 2001 had no impact on the Company's financial position, results of operations
and cash flows.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial
Statements. This bulletin summarizes certain interpretations and practices
followed by the Division of Corporation Finance and the Office of the Chief
Accountant of the Securities and Exchange Commission in administering the
disclosure requirements of the federal securities laws in applying accounting
principles generally accepted in the United States of America to revenue
recognition in financial statements. The adoption of SAB No. 101 in 2000 had no
impact on the Company's financial position, results of operations or cash flows.
5. ACQUISITIONS
Dazzle Multimedia, Inc.
In the first quarter of 2001, SCM acquired an additional 2.8% of the
outstanding share capital of Dazzle Multimedia, Inc. (Dazzle), a consolidated
subsidiary, for approximately $2.4 million. The $2.4 million increased
intangible assets by $2.3 million, and $0.1 million was expensed in the first
quarter of 2001 for Dazzle's research and development efforts that had not
reached technological feasibility and had no future uses per an independent
valuation.
6. SEGMENT REPORTING, GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS
SCM 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 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 and Video, Digital Media and Connectivity and PC Security.
The executive staff reviews financial information and business
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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 for the quarters ended March 31, 2001 and
2000, is as follows (in thousands):
Quarter Ended
March 31,
--------------------------
2001 2000
------- -------
Digital TV and Video:
Revenues $24,379 $15,562
Gross profit 1,406 6,004
Digital Media and Connectivity:
Revenues $16,215 $11,317
Gross profit 1,432 3,632
PC Security:
Revenues $ 4,513 $ 5,193
Gross profit 1,406 2,330
Geographic revenues are based on the country where the customers are
located. Information regarding revenues by geographic region for the three
months ended March 31, 2001 and 2000 are as follows (in thousands):
2001 2000
------- -------
United States $19,043 $15,958
Europe 16,471 11,404
Asia-Pacific 9,593 4,710
------- -------
$45,107 $32,072
======= =======
One customer represented 12% of SCM's total net revenue for the quarter
ended March 31, 2001. No customers exceeded 10% of total net revenue for the
quarter ended March 31, 2000.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q contains forward-looking statements
that are subject to a number of risks and uncertainties, many of which are
beyond our control. All statements, other than statements of historical facts
included in this Quarterly Report on Form 10-Q regarding our strategy, future
operations, financial position, estimated revenues or losses, projected costs,
prospects, plans and objectives of management are forward-looking statements.
When used in this Quarterly Report on Form 10-Q, the words "will", "believe",
"anticipate", "estimate", "expect" and similar expressions are intended to
identify forward-looking statements, although not all forward-looking statements
contain such identifying words. All forward-looking statements speak only as of
the date of this Quarterly Report on Form 10-Q. You should not place undue
reliance on these forward-looking statements. Although we believe that our
plans, intentions and expectations reflected in or suggested by the
forward-looking statements that we make in this Quarterly Report on Form 10-Q
are reasonable, we can give no assurance these plans, intentions or expectations
will be achieved. We disclose important factors that could cause our actual
results to differ materially from our expectations under "Factors That May
Affect Future Operating Results". These cautionary statements qualify all
forward-looking statements attributable to us or persons acting on our behalf.
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,
Digital Video, PC Security and Digital Media Transfer markets. Our target
customers are end user consumers as well as 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, both to the retail channel and 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 and Video, PC Security and Digital
Media and Connectivity. We were organized in Delaware in 1996.
ACQUISITIONS
Dazzle Multimedia Inc.
In the first quarter of 2001, SCM acquired an additional 2.8% of the
outstanding share capital of Dazzle Multimedia, Inc. (Dazzle), a consolidated
subsidiary, for approximately $2.4 million. The $2.4 million increased
intangible assets by $2.3 million, and $0.1 million was expensed in the first
quarter of 2001 for Dazzle's research and development efforts that had not
reached technological feasibility and had no future uses per an independent
valuation.
RESULTS OF OPERATIONS
Net Revenue. Revenue from product sales is recognized upon product
shipment, when a purchase order has been received, the sales price is fixed and
determinable and collection of the resulting receivable is probable. Provisions
for estimated warranty repairs and returns and allowances are provided for at
the time products are shipped. Net revenue for the quarter ended March 31, 2001
was $45.1 million compared to $32.1 million in 2000, an increase of 41%. The
increase in revenue in the first quarter of 2001 over the same quarter in 2000
was due primarily to an increase in shipments of our Digital TV and Video
products of $8.8 million and an increase in shipments of Digital Media and
Connectivity products of $4.9 million, partially offset by a $0.7 million
decrease in PC Security products. The increase in our Digital TV and Video
revenue was primarily due to increased shipments of our conditional access
modules for digital television broadcasts in Europe. The increase in Digital
Media and Connectivity revenue was primarily due to increased shipments of
digital photography related products in the United States sold through the
retail channel by Microtech, which was acquired at the end of the second quarter
of 2000. Revenue from our PC Security products decreased primarily due to
reduced demand for our legacy SwapBox products, which were included in 2000
figures
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but not included in 2001. Sales to SCM's top 10 customers accounted for 47% and
41% of total net revenues in the first quarter of 2001 and 2000, respectively.
Gross Profit. Gross profit for the first quarter of 2001 was $4.2
million, or 9% of total net revenue, compared to $12.0 million, or 37%, for the
first quarter of 2000. The decrease in gross profit in absolute dollars for the
first quarter of 2001 was primarily due to a $10.0 million increase in inventory
reserves for our St@rKey PC satellite receiver and our digital media reader
products and related components. Our St@rKey product was designed to receive
MPEG 1 video over satellite, but changing market requirements prompted us to try
and rework the product to receive MPEG 2 video. Following the end of the first
quarter, we determined that St@rKey was not technically feasible to manage MPEG
2 in its current form, and therefore have taken a charge to inventory for this
product and have begun to rearchitect St@rKey to meet current market
requirements. We increased inventory reserves for our digital media readers,
which are custom built for individual customers, after experiencing
cancellations of orders and reducing our expectations for future sales of these
products due to generally weaker economic conditions. Without the inventory
charge, gross profit for the first quarter would have been 32% of total revenue,
compared with 37% for the same period of 2000. This decrease in gross margin
percentage from 32% without the inventory write-offs in the first quarter of
2001 compared to 37% for the same period in 2000 was primarily due to shifts in
product margins within our divisions and to lower margins associated with sales
of our Dazzle branded products into the retail channel. Our gross profit has
been and will continue to be affected by a variety of factors, including
competition, the volume of sales in any given quarter, 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 fees for the development of prototype
products. 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 2001, research and
development expenses were $3.6 million, compared with $2.7 million in the first
quarter of 2000, an increase of 32%. As a percentage of total net revenues,
research and development expenses were 8% in the first quarter of 2001 and 2000.
The increase in absolute amounts was primarily due to engineering headcount and
related product development costs at our development centers in Europe and the
United States. Personnel related expenses increased by $0.5 million and
prototype expenses increased $0.1 million in the first quarter of 2001 compared
to the same quarter in 2000. We believe that the absolute amount of research and
development expenses during 2001 will be higher than in 2000 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.
Selling and Marketing. Selling and marketing expenses consist primarily
of employee compensation and advertising and other marketing costs. Selling and
marketing expenses for the first quarter of 2001 were $8.6 million, or 19% of
revenues, compared with $3.9 million in the first quarter of 2000, or 12% of
revenues, an increase of 122%. These increases in absolute amounts in 2001 were
primarily due to an increase in selling and marketing costs in the U.S. and
Europe. The increases consisted primarily of marketing program costs of $2.1
million, personnel related expenses of $1.6 million, external and internal sales
commissions of $0.5 million, and travel costs of $0.3 million. We expect selling
and marketing expenses in 2001 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
changes to allowances for doubtful accounts receivable. In the first quarter of
2001, general and administrative expenses were $6.2 million, an increase of 139%
compared with $2.6 million in the first quarter of 2000, and representing 14%
and 8% of total net revenue in the first quarter of 2001 and 2000, respectively.
This increase in the absolute amount in 2001 was primarily due to an increase
for allowances for doubtful accounts receivable of $2.0 million and an increase
in compensation expense of $1.0 million. We increased allowances for doubtful
accounts after experiencing increased evidence of delays and non-payments from
some customers in the first quarter, in some cases caused by customers filing
for bankruptcy. The increase in compensation expense primarily was due to our
acquisition of Microtech at the end of the second quarter of 2000 and to added
infrastructure in the United States. We believe that the headcount-driven
component of general and administrative expenses in 2001 will continue to
increase in absolute amounts over 2000 levels as we continue to strengthen our
infrastructure. We expect general and administrative costs will fluctuate as a
percentage of total net revenue.
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Amortization of Goodwill and Intangibles. Amortization of goodwill and
intangibles in the first quarter of 2001 was $3.7 million compared with $0.4
million for the same period of 2000. The increase in goodwill and intangible
amortization resulted from our acquisitions of Microtech, 2-Tel and Dazzle and
from Dazzle's acquisition of FAST's Personal Video Division during the past four
quarters.
In-Process Research and Development. In-process research and development
costs of $0.1 million in the first quarter of 2001 were for development efforts
that had not yet reached technological feasibility at the time of our residual
2.8% acquisition of Dazzle's share capital. These development efforts had no
alternative future uses as of the acquisition date.
Loss from investments. From time to time, we make strategic investments
in both private and public companies. During each quarter, we evaluate our
investments for possible asset impairment. We examine a number of factors
including the current economic conditions and markets for each investment, as
well as its cash position and anticipated cash needs for the short- and
long-term. During the first quarter of 2001, because of the persistent
deterioration of general economic conditions, changes in specific market
conditions for each investment and difficulties involved in obtaining additional
funding, SCM determined that our investments in SmartDisk and Spyrus have been
permanently impaired. Accordingly, we wrote down our investment in SmartDisk to
its fair market value as of March 31, 2001 and wrote down our investment in
Spyrus to its estimated value which approximated 20% of the original cost. The
result was a charge to the income statement of $5.7 million in the first quarter
of 2001. (See Note 2 to our condensed consolidated financial statements).
Interest and Other, Net. Interest 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 2001, interest
income and other, net, was a net expense of $33,000, compared to a net gain of
$1.8 million in the first quarter of 2000. Net interest income for the first
quarter of 2001 was $0.7 million compared to $1.7 million for the same period in
2000. The decrease was primarily the result of lower average investable cash
balances. Net foreign currency loss for the first quarter of 2001 was $0.7
million compared to a gain of $0.1 for the first quarter of 2000. The decrease
in the first quarter of 2001 was primarily due to unfavorable exchange rate
changes for the Japanese yen and the German mark compared to the U.S. dollar.
Benefit (Provision) for Income Taxes. The benefit for income taxes in
the first quarter of 2001 was $5.2 million, or a 22% income tax benefit compared
to a tax provision with a federal statutory rate of 34%. This effective benefit
resulted principally from net losses in the United States and Europe which were
partially offset by taxable income generated in other tax jurisdictions. The
effective tax benefit was further reduced by expenses not deductible for tax
purposes primarily consisting of the amortization of goodwill and intangibles.
Minority interest. The minority interest in earnings reflects the
proportional profits or losses that are attributable to the minority
shareholders in two of SCM's subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2001, our working capital was $104.7 million, compared
to working capital of $123.7 million as of December 31, 2000. The decrease in
working capital as of March 31, 2001 related primarily to uses of cash from
operations of $11.1 million and from investing activities of $3.4 million. Cash
used in operations of $11.1 million was primarily due to: a net loss of $18.4
million, deferred income taxes of $5.2 million, a decrease of accruals of $3.8
million and an increase in other assets of $2.0 million. These were only
partially offset by a loss on investments of $5.7 million, depreciation and
amortization of $4.5 million, a decrease in receivables of $4.1 million and an
increase in accounts payable of $3.2 million. Uses of cash from investing
activities were primarily due to capital expenditures of $2.1 million and from
the purchase of Dazzle share capital of $2.4 million which were only partially
offset by a net increase in maturities of short-term investments of $1.1
million.
SCM has revolving lines of credit with two banks in Germany providing
total borrowings of up to DM 3.0 million (approximately $1.3 million as of March
31, 2001). Both lines have no expiration date. The German lines of credit bear
interest at rates ranging from 7.25% to 10.0%, and borrowings under these lines
of credit are
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unsecured. We have an unsecured line of credit in France of FF 2.0 million
(approximately $0.3 million as of March 31, 2001) which bears interest at 5.86%
and expires in May 2001. In the United States, we have an unsecured $3.0 million
line of credit which bears interest at 8.5% and expires in May 2001. In
addition, we have a Singapore $1.2 million (approximately U.S. $0.7 million as
of March 31, 2001) overdraft facility with a local bank due on demand. The
Singapore line is secured by a U.S. $0.4 million fixed deposit and has a base
interest rate of 6.5%. At March 31, 2001, no amounts were outstanding under any
of our lines of credit.
We believe that our current capital resources and available borrowings
will be sufficient to meet our operating and capital requirements through at
least the next twelve months. 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.
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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 our company. 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, results of operations or product market share 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.
We have a history of losses with an accumulated deficit of $24.4 million
as of March 31, 2001. We were not profitable in the first quarter of 2001 before
or after one-time charges. We may be unable to attain, or if attained, sustain
profitability on an annual or quarterly basis in the future.
OUR QUARTERLY OPERATING RESULTS WILL LIKELY FLUCTUATE.
Our quarterly operating results have varied greatly in the past and will
likely vary greatly in the future depending upon a number of factors. Many of
these factors are beyond our control. Our revenues, gross margins and operating
results may fluctuate significantly from quarter to quarter due to, among other
things:
- - the timing and amount of orders we receive from our customers which, in
the case of our consumer products and products sold to the government,
may be tied to seasonal demand or budgetary cycles;
- - cancellations or delays of customer product orders, or the loss of a
significant customer;
- - our backlog and inventory levels;
- - our customer and distributor inventory levels and product returns;
- - 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;
- - the sales volume, product configuration and mix of products that we
sell;
- - our success in expanding our sales and marketing organization and
programs;
- - technological changes in the market for our products;
- - increased competition or reductions in the average selling prices that
we are able to charge;
- - fluctuations in the value of foreign currencies against the U.S. dollar;
- - the timing and amount of marketing and research and development
expenditures;
- - our investment experience related to our strategic minority equity
investments;
- - costs related to events such as acquisitions, litigation and write-off
of investments; and
- - business and economic conditions overall and in our markets.
Due to these and other factors, our revenues may not increase or remain
at their current levels. Should market conditions cause us to take write-offs
against inventory, doubtful accounts or investments, our operating expenses
could increase. In addition, because a high percentage of our operating expenses
are fixed, a small variation in our revenue can cause significant variations in
our earnings from quarter to quarter and our operating results may vary
significantly in future periods. Therefore, our historical results may not be a
reliable indicator of our future performance.
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THE TIMING AND AMOUNT OF OUR REVENUES ARE SUBJECT TO A NUMBER OF FACTORS THAT
MAKE IT DIFFICULT TO ESTIMATE OPERATING RESULTS PRIOR TO THE END OF A QUARTER.
We do not typically maintain a significant level of backlog. As a
result, revenues in any quarter are dependent on contracts entered into or
orders booked and shipped in that quarter. In recent periods, customers,
including distributors of our consumer products, have tended to make a
significant portion of their purchases towards the end of the quarter, in part
because they are able, or believe that they are able, to negotiate lower prices
and more favorable terms. This trend makes predicting revenues more difficult.
The timing of closing larger orders increases the risk of quarter-to-quarter
fluctuation. If orders forecasted for a specific group of customers for a
particular quarter are not realized or revenues are not otherwise recognized in
that quarter, our operating results for that quarter could be materially
adversely affected.
WEAKNESS IN THE ECONOMY COULD DECREASE DEMAND FOR OUR PRODUCTS OR FOR OUR
CUSTOMERS' PRODUCTS, CAUSING CUSTOMERS TO DECREASE OR CANCEL ORDERS TO US OR TO
DELAY PAYMENT.
In recent months, economic uncertainty in the U.S. has resulted in
decreased demand from end users for many companies' products, including ours.
Specifically, in the first quarter of 2001 we experienced decreased demand for
our Dazzle digital video editing products and for our digital media
reader/writers sold through the retail and OEM channels. In addition to
impacting our retail business, reductions in consumer spending may impact our
OEM business as well, as OEM customers may reduce or cancel orders for our
products if their own visibility of future orders is compromised by decreased
demand. Reduced or canceled orders for our products could lead to decreased
sales in a particular period, and could also cause us to write off inventory, as
many of our products are custom made for particular customers. In some cases,
customers could delay payment or be unable to pay for orders made to us, causing
us to increase our allowance for doubtful accounts or to write off certain
receivables. Decreased sales or any write-offs, or both, could have a materially
adverse affect on our operating results in any given period.
OUR LISTING ON THE NEUER MARKT OF THE FRANKFURT STOCK EXCHANGE IN ADDITION TO
OUR LISTING ON THE NASDAQ NATIONAL MARKET EXPOSES OUR STOCK PRICE TO ADDITIONAL
RISKS OF FLUCTUATION.
Our common stock experiences a significant volume of trading on the
Neuer Markt of the Frankfurt Stock Exchange. Because of this, factors which
would not otherwise affect a stock traded solely on Nasdaq may cause our stock
price to fluctuate. Investors outside the United States may react differently
and more negatively than investors in the U.S. to events such as acquisitions,
one-time charges, lower than expected revenue or earnings announcements. Any
negative reaction by investors in Europe to such events could cause our stock
price to decrease. In addition, European market conditions in general, or
downturns on the Neuer Markt specifically, regardless of the Nasdaq market
conditions, could negatively impact our stock price.
OUR STOCK PRICE HAS BEEN AND IS LIKELY TO REMAIN VOLATILE.
The stock market has recently experienced significant price and volume
fluctuations that have particularly affected the market prices of the stocks of
technology companies. During the 12-month period from May 10, 2000 to May 10,
2001, the reported last sale price for our common stock on the Nasdaq market
ranged from $9.70 to $101.34 per share. Volatility in our stock price may result
from a number of factors, including:
- - variations in our or our competitors' financial and/or operational
results;
- - the fluctuation in market value of comparable companies in any of our
markets;
- - comments and forecasts by securities analysts;
- - expected or announced relationships with other companies;
- - any loss of key management;
- - announcements of technological innovations or new products by us or our
competition;
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- - litigation developments; and
- - general market downturns.
In addition, we may not discover, or be able to confirm, revenue or
earnings shortfalls until the end of a quarter, which could result in an
immediate drop in our stock price. 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 our
management's attention and resources.
OUR SALES ARE DEPENDENT ON SEVERAL EMERGING MARKETS, WHICH MAY NOT DEVELOP.
We sell our products primarily to emerging markets which have not yet
reached a stage of mass adoption or deployment. If demand for products in the
Digital TV, Digital Video, PC Security and/or Digital Media Transfer markets
does not develop and grow sufficiently, our revenues and profit margins could
level off or decline. We cannot predict the future growth rate, if any, or size
or composition of the market of our products in any of these markets. The demand
and market acceptance for our products, as is common for new technologies, will
be subject to high levels of uncertainty and risk and may be influenced by
several factors including:
- - the slow pace and uncertainty of adoption in Europe of conditional
access modules such as ours which use the DVB-CI standard;
- - the strength of entrenched security and set-top receiver suppliers in
the U.S. who may resist the use of removable conditional access modules
such as ours and prevent or delay opening the U.S. digital television
market to greater competition;
- - the ability of financial institutions and the U.S. government to create
and deploy smart card-based applications that will drive demand for
smart card readers such as ours;
- - the ability of flash memory card manufacturers to develop higher
capacity memory cards that will drive demand for readers that enable
rapid transfer of large amounts of data such as ours; and
- - general economic conditions.
OUR FUTURE SUCCESS WILL DEPEND ON OUR ABILITY TO KEEP PACE WITH TECHNOLOGICAL
CHANGE AND MEET THE NEEDS OF OUR TARGET MARKETS AND CUSTOMERS.
The markets for our Digital TV, Digital Video, PC Security and Digital
Media Transfer 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 or the adoption of new industry standards could render our
existing products obsolete and unmarketable. If one of our products is deemed to
be obsolete or unmarketable, then we might have to reduce revenue expectations
or write off inventories for that product. Our future success will depend upon
our ability to enhance our current products and to develop and introduce new
products on a timely basis that address the increasingly sophisticated needs of
our customers and that keep pace with technological developments, new
competitive product offerings and emerging industry standards.
For example, in the Digital TV market, our products provide a means of
controlling access to digital television broadcasts. We are currently
developing, with Microsoft, technology that will allow software-based
entertainment set-top boxes to access premium digital television broadcasts. If
we are not successful in making this technology highly reliable and easy to
implement, we may not be able to sell it to potential customers such as consumer
electronics companies or broadcasters.
In the PC Security market, our SmartReady, SmartSecure, SmartTrust and
SmartRetail product families are designed to provide smart card-based security
for PCs. Smart cards are beginning to be widely deployed by financial
institutions, the U.S. government, corporations and other large organizations,
in advance of anticipated security-oriented applications. However, the market
for network and electronic commerce security applications is still emerging and
the smart card may not become the industry standard. In this case, demand for
our readers will not
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grow. In addition, standards for smart card readers are still emerging. We may
not be able to comply with emerging standards in a timely manner or at all. If
we cannot meet the standards requirements of the market or our prospective
customers, we would likely lose orders to competitors.
Because we operate in markets for which industry-wide standards have not
yet emerged, it is possible that any standards eventually adopted could prove
disadvantageous to or incompatible with our business model and product lines. 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.
OUR MARKETS ARE HIGHLY COMPETITIVE AND OUR CUSTOMERS MAY PURCHASE PRODUCTS FROM
OUR COMPETITORS.
The market for our products is intensely competitive and characterized
by rapidly changing technology. We believe that the principal competitive
factors affecting the market for digital data security and connectivity products
include:
- - the extent to which products support existing industry standards and
provide interoperability;
- - technical features;
- - ease of use;
- - quality and reliability;
- - level of security;
- - brand name, particularly in retail channels;
- - strength of distribution channels; and
- - price.
We believe that competition in our markets 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:
- - Pinnacle in digital video capture and conversion products;
- - ActionTec, Carry Computer Engineering and Greystone in PC Card adapters;
- - Advanced Card Systems and O2 Micro in smart card interface chips;
- - Advanced Card Systems, Gemplus, Infineer, Litronic, PubliCard and
Towitoko in smart card readers and universal smart card reader
interfaces; and
- - Carry Computer Engineering, DataFab, Lexar, SanDisk, Simple Technology
and SmartDisk for digital media and connectivity.
We also experience indirect competition from some of our customers who
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, 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.
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WE FACE RISKS RELATED TO OUR INCREASED DEPENDENCE ON A RETAIL DISTRIBUTION
MODEL.
Historically, we sold substantially all our products directly to OEM
customers. Following our acquisitions of Dazzle Multimedia and Microtech, we now
sell a significant percentage of our products directly to the retail channel.
Direct retail distribution is a relatively new model for us and we face
additional risks and requirements including:
- - generally lower margins for products due to, among other factors,
greater price competition and increased promotional and distribution
costs;
- - the need to develop, and the related marketing expense of developing
brand recognition for our Dazzle and Microtech branded products;
- - the need to protect the reputation of our brands for quality and value;
and
- - the need to successfully and cost-effectively develop new retail
distribution channels for these products.
We are contractually obligated to accept returned products from our
distributors and OEM customers only on a limited basis. However, if consumer
demand is less than anticipated our distributors and OEMs may seek to return
products to us. We may determine that it is in our best interest to accept
returns in order to maintain good relations. While we have experienced some
product returns to date, returns may increase even more than present levels in
the future.
Our retail distributors may have limited capital to invest in inventory,
and their decisions to purchase our products are partly a function of pricing,
terms and special promotions offered by us and our competitors over which we
have no control and which we cannot predict. Our distributor agreements are
generally nonexclusive and may be terminated by either party without cause.
Certain distributors have experienced financial difficulties in the past.
Distributors that account for significant sales of our consumer products may
experience financial difficulties in the future, which could lead to reduced
sales or write-offs.
WE HAVE GLOBAL OPERATIONS WHICH REQUIRE SIGNIFICANT MANAGERIAL AND
ADMINISTRATIVE RESOURCES.
Operating in diverse geographic locations imposes significant burdens on
our managerial resources. In particular our management must divert a significant
amount of time and energy to manage employees and contractors from diverse
cultural backgrounds and who speak different languages, manage different product
lines for different markets, manage our supply and distribution channels across
different countries and business practices, and coordinate these efforts to
produce an integrated business effort, focus and vision. In addition, we are
subject to the difficulties associated with operating in a number of time zones
which may subject us to additional unforeseen difficulties or logistical
barriers. Operating in widespread geographic locations requires us to implement
and operate complex information and operational systems. In the future we may
have to exert managerial resources and implement new systems which 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.
MANY OF OUR CUSTOMERS ARE LOCATED IN OTHER COUNTRIES WHICH EXPOSES OUR BUSINESS
TO RISKS RELATED TO INTERNATIONAL SALES.
We were originally a German corporation and we continue to conduct a
substantial portion of our business in Europe. Approximately 58% of our revenues
for the three months ended March 31, 2001 and 48%, 52%, and 62% for the years
ended December 31, 2000, 1999, and 1998, 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:
- - foreign currency exchange rate change, especially since we do not
currently engage in hedging activities with respect to our foreign
currency exposure;
- - tariffs and other trade barriers, including import and export
restrictions;
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- - potential adverse tax consequences;
- - political or economic instability;
- - compliance with foreign laws;
- - difficulties in protecting intellectual property rights in foreign
countries; and
- - transportation delays and interruptions.
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, with net revenue increasing from
$23.6 million in 1995 to $157.8 million in 2000. Net revenue for the first
quarter of 2001 was $45.1 million. We have expanded our business from the PC
Security market to include the Digital TV, Digital Video and Digital Media
Transfer markets. Managing businesses in each of these markets requires skilled
management and substantial resources. To address our need for additional
resources and because of various acquisitions, we have increased in size from 67
employees at December 31, 1995 to 549 as of December 31, 2000. We had 554
employees at March 31, 2001.
Our growth and our growth plans have placed and are likely to continue
to place a significant burden on our operating and financial systems and
increase responsibility for senior management and other personnel. Our existing
management or any new members of management may not be able to improve our
existing systems and controls or implement new systems and controls in response
to our anticipated growth. In addition, our intention to reduce or redeploy
personnel to reduce expenses from time to time may limit our capacity to grow.
OUR OEM CUSTOMERS MAY DEVELOP TECHNOLOGY SIMILAR TO OURS, RESULTING IN A
REDUCTION IN RELATED CUSTOMER PURCHASES, CANCELED ORDERS AND DIRECT COMPETITION
FROM THESE CUSTOMERS.
We sell our products to many original equipment manufacturers who
incorporate our products into their offerings or who resell our products in
order to provide a more complete solution to their customers. If our OEM
customers develop their own products to replace ours, this would result in a
loss of sales to those customers as well as increased competition for our
products in the marketplace. In addition, these OEM customers could cancel
outstanding orders for our products, which could cause us to write down
inventory already designated for those customers. For example, in the past,
SanDisk Corporation has purchased various Digital Media Transfer products from
us and marketed them under the SanDisk brand. Recently, SanDisk developed a
Digital Media Transfer product of its own and has begun marketing it.
Consequently, in the first quarter of 2001, SanDisk canceled orders for our
digital media readers. Going forward, SanDisk may not place orders for our
products, which could decrease our revenues. In addition, SanDisk may market its
competing products to other potential customers.
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 revenue and operating income in the first quarter
and second quarter and higher revenue in the third quarter and fourth quarter of
each calendar year. We believe that the seasonal trends in our business and
operating results are primarily due to the retail selling cycles of our
consumer-oriented products, including our Digital Video and Digital Media
Transfer products. Because the market for consumer products is stronger in the
second half of the year, we expect that our sales to retail distributors and to
consumer-oriented OEMs will increase during that period.
WE FACE RISKS ASSOCIATED WITH OUR PAST AND FUTURE ACQUISITIONS.
A component of our business strategy is to seek to buy businesses,
products and technologies that complement or augment our existing businesses,
products and technologies. In 2000, we completed four acquisitions:
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- - Microtech in June 2000;
- - 2-Tel B.V. in September 2000;
- - Dazzle Multimedia in December 2000, by acquiring substantially all of
the outstanding minority interest; and
- - the Personal Video Division of FAST Multimedia in July 2000, an
acquisition completed through Dazzle Multimedia.
The integration of the business and operations of any past or future
acquisition is a complex, time consuming and expensive process. In order to
successfully integrate any acquisition, we must, among other things,
successfully:
- - attract and retain key management and other personnel;
- - integrate, both from an engineering and a sales and marketing
perspective, the acquired products into our product offerings;
- - coordinate research and development efforts;
- - integrate sales forces;
- - consolidate duplicate facilities; and
- - cost effectively manage our combined business.
Past and future acquisitions may disrupt ongoing operations, divert
management from day-to-day business and adversely impact our results of
operations. In addition, these types of transactions often result in charges to
earnings for such things as transaction expenses, amortization of goodwill, or
expensing of in-process research and development. Our available cash and our
securities may be used to buy or invest in companies or products, which could
result in significant acquisition-related charges to earnings and dilution to
our stockholders. Moreover, if we buy a company, we may have to incur or assume
that company's liabilities, including liabilities that are unknown at the time
of acquisition. We may be unable to complete any given acquisition which may
limit our future revenues.
WE WILL EXPERIENCE SIGNIFICANT AMORTIZATION CHARGES AND FACE THE RISK OF FUTURE
CHARGES AS A RESULT OF PAST ACQUISITIONS.
In connection with our previous acquisitions accounted for under the
purchase method of accounting, in future periods we will experience significant
charges related to the amortization of purchased technology and goodwill. In
addition, if we later determine that this purchased technology and goodwill is
impaired, we will be required to take a related non-recurring charge to
earnings. The Financial Accounting Standards Board is addressing accounting for
business combinations which could cause our accounting of goodwill and acquired
intangibles to change.
WE COULD LOSE MONEY AND OUR STOCK PRICE COULD DECREASE AS A RESULT OF OUR
STRATEGIC INVESTMENTS.
We have made strategic minority investments in private and public
companies and in the future we may make additional strategic minority
investments. Our strategic investments involve a number of risks and we may not
realize the expected benefits of these transactions. We may lose all or a
portion of our investment, particularly in the case of our private investments.
If we were to lose these investments, or if the investments were determined to
be impaired, we would be forced to write off all or a portion of these
investments.
OUR KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS AND SUCH KEY PERSONNEL MAY NOT
REMAIN WITH US 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.
We provide 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, certain of our
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executive officers are subject to one-year non-compete agreements. Non-compete
agreements are, however, generally difficult to enforce. Even though we provide
competitive compensation arrangements to our executive officers and other
employees, we cannot be certain that we will be able to retain them, including
those individuals that are subject to non-compete agreements.
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.
WE MAY BE EXPOSED TO RISKS OF INTELLECTUAL PROPERTY INFRINGEMENT BY THIRD
PARTIES.
Our 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. We generally enter into confidentiality and non-disclosure
agreements with our employees and with key vendors and suppliers. For example,
our SmartOS and SmartReady trademarks are registered in the United States. We
continuously evaluate the registration of additional trademarks as appropriate.
We currently have patents issued in both the United States and Europe and have
other patent applications pending worldwide. In addition, we have licenses for
various other United States and European 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. 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. Because many of our
products are sold and a portion of our business is conducted overseas, primarily
in Europe, our exposure to intellectual property risks may be higher. Our means
of protecting our proprietary and intellectual property rights may not be
adequate.
OUR PRODUCTS MAY HAVE DEFECTS, WHICH COULD DAMAGE OUR REPUTATION, DECREASE
MARKET ACCEPTANCE OF OUR PRODUCTS, CAUSE US TO LOSE CUSTOMERS AND REVENUE, AND
RESULT IN LIABILITY TO US.
Highly complex products such as our Digital Video hardware and software
solutions may contain defects for many reasons, including defective design or
defective material. Often, these defects are not detected until after the
products have been shipped. If any of our products contains defects, or has
reliability, quality or compatibility problems, our reputation might be damaged
significantly, we could lose or experience a delay in market acceptance of the
affected product or products, and we might be unable to retain existing
customers or attract new customers. In addition, these defects could interrupt
or delay sales. We may have to invest significant capital, technical, managerial
and other resources to correct potential problems and potentially divert these
resources from other development efforts. If we fail to provide solutions to
potential problems, we could also incur product recall, repair or replacement
costs. These potential problems might also result in claims against us by our
customers or others.
WE MAY FACE CLAIMS OF INFRINGEMENT OF THE INTELLECTUAL RIGHTS OF THIRD PARTIES,
WHICH COULD SUBJECT US TO COSTLY LITIGATION, SUPPLIER AND CUSTOMER
INDEMNIFICATION CLAIMS AND THE POSSIBLE RESTRICTION ON THE USE OF OUR
INTELLECTUAL PROPERTY.
We have from time to time received claims that we are infringing upon
third parties' intellectual property rights. Our suppliers and customers may
also receive similar claims. We have historically agreed to indemnify suppliers
and customers for alleged patent infringement. The scope of this indemnity
varies, but may, in some instances, include indemnification for damages and
expenses, including attorney's fees. We may periodically engage in litigation as
a result of these indemnification obligations. Our insurance policies exclude
coverage for third party claims for patent infringement.
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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 enter into royalty or licensing agreements. If we
are unable to modify our products or obtain a license on commercially reasonable
terms, or at all, a competitor of ours or a claimant against us or our customers
may stop us or our customers from selling the allegedly infringing products.
If we decide to incorporate third party technology into our products or
if we are found to infringe on others' intellectual property, we could be
required to license intellectual property from a third party. We may also need
to license some of our intellectual property to others in order to enable us to
obtain cross-licenses to third party patents. We cannot be certain that licenses
will be offered when we need them, or that the terms offered will be acceptable.
If we do obtain licenses from third parties, we may be required to pay license
fees or royalty payments. In addition, if we are unable to obtain a license that
is necessary to the manufacture of our products, we could be required to suspend
the manufacture of products or stop our suppliers from using processes that may
infringe the rights of third parties. We may be unsuccessful in redesigning our
products or in obtaining the necessary licenses under reasonable terms or at
all.
WE MAY FACE CLAIMS BASED ON PRODUCT LIABILITY THAT WOULD SUBJECT US TO COSTLY
LITIGATION AND DECREASED PRODUCT DEMAND.
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, these measures may be
ineffective 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.
A SIGNIFICANT PORTION OF OUR SALES COMES FROM A SMALL NUMBER OF CUSTOMERS AND
THE LOSS OF ONE OF MORE OF THESE CUSTOMERS COULD NEGATIVELY IMPACT OUR OPERATING
RESULTS.
Our products are generally targeted at OEM customers in the consumer
electronics, computer, digital appliance, digital media and conditional access
system industries, and to retail distributors. Sales to a relatively small
number of customers historically have accounted for a significant percentage of
our total sales. For example, sales to our top 10 customers accounted for
approximately 37% of our total net revenues in 2000, with no customer accounting
for 10% or more of our revenues. Sales to our top 10 customers accounted for
approximately 47% of our total net revenues for the first quarter of 2001, with
one customer accounting for 12% of our revenues. 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 OEM or retail 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
result in decreased revenues and/or inventory or receivables write-offs and
otherwise harm our business and operating results.
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 or retail distributor, 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
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 would limit our receipt of new revenue and
might cause us to expend more resources to obtain new customer wins.
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OUR BUSINESS COULD SUFFER IF WE OR OUR CONTRACT MANUFACTURERS CANNOT MEET
PRODUCTION REQUIREMENTS.
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, we have shifted volume production of many of our product
components to our wholly owned subsidiary in Singapore, SCM Microsystems (Asia)
Pte. Ltd. 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 be unable 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 design and manufacture 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.
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, we currently purchase ASICs for our Digital TV
modules exclusively from TEMIC, Philips and Atmel, smart card connectors
exclusively from ITT Canon and another supplier and DTV/SwapSmart mechanical
components exclusively from Stocko. 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.
FACTORS BEYOND OUR CONTROL COULD DISRUPT OUR OPERATIONS AND INCREASE OUR
EXPENSES.
We face a number of potential business interruption risks that are
beyond our control. The State of California has recently experienced
intermittent power shortages, sharp increases in the cost of energy and even
interruptions of service to some business customers. If power shortages continue
to be a problem our business may be materially adversely effected. Additionally,
we may experience natural disasters that could interrupt our business. Our
corporate headquarters is located near a major earthquake fault. The impact of a
major earthquake on our facilities, infrastructure and overall operations is not
known. Safety precautions have been implemented; however there is no guarantee
that an earthquake would not seriously disturb our entire business process.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK FOREIGN
CURRENCIES
FOREIGN CURRENCIES
SCM Microsystems transacts business in various foreign currencies,
primarily in certain European countries, the United Kingdom, Singapore and
Japan. Accordingly, we are subject to exposure from adverse movements in foreign
currency exchange rates. This exposure is primarily related to yen denominated
sales in Japan and local currency denominated operating expenses in the UK,
Europe and Singapore, where we sell in both local currencies and U.S. dollars.
We currently do not use financial instruments to hedge local currency activity
at any of our foreign locations. Instead, we believe that a natural hedge
exists, in that local currency revenues substantially offset the local currency
denominated operating expenses. We assess the need to utilize financial
instruments to hedge foreign currency exposure on an ongoing basis.
SCM's foreign currency transactions gains and losses are primarily the
result of the revaluation of intercompany receivables/payables (denominated in
U.S. dollars) and trade receivables (denominated in a currency other than the
functional currency) to the functional currency of the subsidiary.
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 UPON SENIOR SECURITIES
Not applicable.
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 2001.
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ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
None
(b) Reports on Form 8-K
None.
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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 11, 2001
/s/ ANDREW WARNER
-------------------------------------------
Andrew Warner
Vice President, Finance and Chief Financial
Officer (Principal Financial and Accounting
Officer)
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