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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10 - Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 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)
------------------------------------
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 8, 1998, 11,198,331 shares of common stock were outstanding.
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PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
SCM MICROSYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended
March 31
--------------------
1998 1997
------- -------
<S> <C> <C>
Net sales:
Security and access products $ 7,815 $ 4,202
PCMCIA peripheral products -- 163
------- -------
Total net sales 7,815 4,365
Cost of sales 4,916 2,804
------- -------
Gross profit 2,899 1,561
------- -------
Operating expenses:
Research and development 766 628
Sales and marketing 1,044 975
General and administrative 778 548
------- -------
Total operating expenses 2,588 2,151
------- -------
Income (loss) from operations 311 (590)
Interest and other income, net 728 36
------- -------
Income (loss) before income taxes 1,039 (554)
Provision for income taxes 250 --
------- -------
Net income (loss) 789 (554)
Accretion on redeemable convertible preferred stock -- (160)
------- -------
Net income (loss) attributable to common stockholders $ 789 $ (714)
======= =======
Earnings (loss) per share:
Basic net income (loss) $ 0.07 $ (0.49)
======= =======
Diluted net income (loss) per share $ 0.07 $ (0.49)
======= =======
Shares used to compute basic net income (loss) per share 10,794 1,468
======= =======
Shares used to compute diluted net income (loss) per share 12,068 1,468
======= =======
</TABLE>
See accompanying notes to financial statements.
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SCM MICROSYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(amounts in thousands)
ASSETS
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
-------- --------
Current assets: (unaudited)
<S> <C> <C>
Cash and cash equivalents $ 23,813 $ 25,552
Short-term investments 34,715 30,336
Accounts receivable 7,782 6,607
Inventories 3,441 3,392
Prepaids and other current assets 777 302
-------- --------
Total current assets 70,528 66,189
Property, equipment, and other assets, net 1,653 1,176
-------- --------
$ 72,181 $ 67,365
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable -- 9
Accounts payable 2,431 4,308
Accrued expenses 1,387 1,271
Income taxes payable 554 305
-------- --------
Total current liabilities 4,372 5,893
Stockholders' equity:
Common Stock 12 11
Additional paid-in capital 75,640 69,902
Accumulated deficit (6,925) (7,714)
Deferred compensation (111) (125)
Cumulative translation adjustment (807) (602)
-------- --------
Total stockholders' deficit 67,809 61,472
-------- --------
$ 72,181 $ 67,365
======== ========
</TABLE>
See accompanying notes to financial statements.
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SCM MICROSYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)
(unaudited)
<TABLE>
<CAPTION>
THREE-MONTH PERIODS
ENDED MARCH 31,
-----------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 789 $ (554)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 128 113
Amortization of deferred employee compensation 13 17
Changes in operating assets and liabilities:
Accounts receivable (1,343) 495
Inventories (116) (248)
Prepaid expenses (880) (194)
Accounts payable (1,297) (1,082)
Accrued expenses (365) 363
Income taxes payable 250 --
-------- --------
Net cash used in operating activities (2,821) (1,090)
-------- --------
Cash flows used in investing activities:
Capital expenditures (225) (114)
Proceeds from short-term investments 9,162 --
Purchases of short-term investments (13,541) --
-------- --------
Net cash used in investing activities (4,604) (114)
Cash flows from financing activities:
Payments on notes payable and long-term debt (9) (1,290)
Proceeds from issuance of redeemable
convertible Preferred Stock -- 5,095
Proceeds from issuance of common stock, net 5,739 --
-------- --------
Net cash provided by financing activities 5,730 3,805
-------- --------
Effect of exchange rates on cash (44) (248)
-------- --------
Net increase in cash (1,739) 2,353
Cash at beginnning of period 25,552 2,593
-------- --------
Cash at end of period $ 23,813 $ 4,946
======== ========
Supplemental disclosures of cash flow information:
Cash paid during the period - interest $ -- $ 25
======== ========
Noncash financing activities:
Interest accretion on redeemable convertible
Preferred Stock $ -- $ 160
======== ========
Conversion of related party and non-related party debt
into redeemable convertible Preferred Stock $ -- $ 4,240
======== ========
</TABLE>
See accompanying notes to financial statements.
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SCM MICROSYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 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 March 31, 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 INCOME (LOSS) PER SHARE
Basic Earning Per Share (EPS) is computed using the weighted average number
of common shares outstanding during the period. Dilutive EPS is computed
using the weighted average number of common and dilutive common equivalent
shares outstanding during the period. Dilutive common equivalent shares
consist of common stock issuable upon exercise of stock options and
warrants using the treasury stock method. The following is a reconciliation
of the shares used in the computation of basic and diluted EPS for the
three month periods ended March 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------
1998 1997
------ ------
<S> <C> <C>
Basic EPS - weighted average number of common shares 10,794 1,468
Effect of dilutive common equivalent shares:
Stock options outstanding 983 --
Stock warrants outstanding 291 --
------ ------
Diluted EPS - weighted average number of common shares
and common equivalent shares outstanding 12,068 1,468
====== ======
</TABLE>
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 (loss) for the three months ended March 31, 1998 and
1997 was $585,000 and $(884,000), respectively.
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4. SUBSEQUENT EVENTS
In April 1998, the Company completed a follow-on public offering with the
sale 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, 2,000,000 shares were
sold by shareholders and 1.45 million shares were sold by the Company. The
net proceeds to the Company approximated $84 million.
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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.
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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 Company's quarter ended March 31, 1998 were $7.8 million compared to $4.4
million in the first quarter of 1997, an increase of 79%. All of the Company's
sales in the first quarter of 1998 were derived from security and access
products, compared to $4.2 million for the comparable periods of 1997. This
represents year-over-year growth for security and access products of 86%. The
increase was primarily due to a three-fold increase in the number of DVB-CAM
units shipped into the European market, and a 33% increase in SwapBox revenues,
primarily to OEM customers supplying U.S. government agencies. The Company made
the final shipment of PCMCIA peripheral products in the quarter ended March 31,
1997, completing its exit from this business.
Gross Profit. Gross profit for the first quarter of 1998 was $2.9
million, or 37% of total net sales, compared to $1.6 million, or 36% of total
net sales for the first quarter of 1997. The increase in gross profit, both in
absolute amount and as a percentage of total net sales, was primarily due to the
aforementioned increase in shipments of DVB-CAM units which carry higher gross
margins than the Company's SwapBox products. 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 and product enhancements 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 first quarter of
1998 were $766,000, compared with $628,000 in the first quarter of 1997, an
increase of 22%. As a percentage of total net sales, research and development
expenses were 10% and 14% in the first quarter of 1998 and 1997, respectively.
The increase in absolute amounts was due primarily to higher headcount in the
Company's La Ciotat, France facility and a rise in prototype and related
expenses for the Company's security and access product development. The Company
believes that the absolute amount of research and development expenses during
the remainder of 1998 will be higher than the last three 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 first quarter of 1998 were $1.0 million, compared
with $975,000 in the first quarter of 1997, an increase of 7%. As a percentage
of total net sales, these expenses were 13% in the first quarter of 1998,
compared with 22% in the comparable period of 1997. This increase in absolute
amount
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was due primarily to routine increases in personnel costs and an increase in
trade show costs related to the CEBIT event held in the first quarter of each
year in Hannover, Germany. The decrease in sales and marketing expenses as a
percentage of total net sales in the first quarter of 1998 compared to the first
quarter of 1997 was due to the 79% increase in total net sales discussed above.
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. The Company expects these expenses as
a percentage of total sales to generally remain consistent with or decline
slightly from the 15.2% level reported for 1997.
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 $778,000 in
the first quarter of 1998, or 10% of total net sales, compared with $548,000, or
13% of total net sales in the first quarter of 1997, an increase of 42%. This
increase in absolute amount was primarily due to an increase of administrative
headcount in the Company's U.S. and Pfaffenhofen, Germany offices to support
higher levels of business activities, as well as costs relating to the Company
operating as a public company subsequent to its IPO in October 1997. The Company
believes general and administrative expenses in the remainder of 1998 will
continue to increase in absolute amount for both of the aforementioned reasons,
but will fluctuate as a percentage of total net sales.
Interest and Other Income, Net. Interest and other income, net consists
of interest earned on invested cash, offset by interest paid or accrued on
outstanding debt. In the first quarter of 1998, net interest income was
$728,000, compared to net interest income of $36,000 in the first quarter of
1997. During the first six months of 1997, the Company raised $12.1 million
through the sale of preferred stock, resulting in a reduction of debt and
corresponding interest expense and an increase in investable cash balances. In
October 1997, the Company completed its IPO with the sale of 3.8 million shares
of common stock, a transaction which generated net proceeds to the Company of
approximately $43.7 million. These amounts, along with the $84 million proceeds
of the Company's follow-on stock sale in April 1998, 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 $250,000 was booked in
the first quarter of 1998, an effective tax rate of 24%, 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.
8
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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 follow-on public offering
with the sale 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, 2,000,000 shares were sold
by shareholders and 1.45 million shares were sold by the Company. The net
proceeds to the Company from the follow-on offering approximated $84 million.
As of March 31, 1998, the Company's working capital was $66.1 million,
compared to a working capital of $60.3 million as of December 31, 1997. Working
capital increased during the first three months of 1998 due primarily to the
Company's receipt of $5.7 million in net proceeds from the exercise of warrants
and options.
During the first three months of 1998, cash and cash equivalents
decreased by $1.7 million due primarily to $4.6 million used in investing
activities (which consisted of $225,000 in capital equipment expenditures and
$9.2 million from proceeds from short-term investments and $13.5 million used in
purchases of short-term investments) and financing activities which included
proceeds from issuance of common stock of $5.7 million. Operating activities for
the three months ended March 31, 1998 used $2.8 million of cash, including an
increase in receivables of $1.3 million due primarily to higher revenue levels
in the third month of the quarter, an increase in prepaid expenses of $880,000,
consisting primarily of financing costs relating to the follow-on public
offering completed in April 1998, and a $1.3 million decrease in accounts
payable.
The Company has revolving lines of credit with three banks in Germany
providing total borrowings of up to 1.5 million DM each (approximately $2.4
million in total at March 31, 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 March 31, 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 March 31, 1998 before interest accretion on preferred stock, the
Company incurred a net loss of $554,000 for the three months ended March 31,
1997 and net operating losses on an annual basis from its inception in 1993
through the year ended December 31, 1996. As of March 31, 1998, the Company had
an accumulated deficit of $6.9 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 sales
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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.
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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 March 31,
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 first 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.
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 three months of 1998, sales to BetaDigital
accounted for 49%
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of total net sales, sales to Telenor Conax A.S. accounted for 15% of total net
sales, and sales to the Company's top 10 customers (9 of which are OEMs)
accounted for 83% 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 three 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 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
13
<PAGE> 15
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 of key members of the Company's
management, including its President and Chief Executive Officer, Chief Financial
Officer, Vice President-Operations, and Vice President-Marketing have joined the
Company within the past 22 months. 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 grown from
50 at December 31, 1995 to 78 as of March 31, 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
14
<PAGE> 16
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.
RISK ASSOCIATED WITH ACQUISITIONS
The Company has recently entered into non-binding letters of intent with
two companies (Intermart Systems K.K. in Japan and Intellicard Systems, Pte Ltd
in Singapore) regarding the acquisition of such companies by the Company, and
the Company's strategy is to pursue additional acquisitions and similar
opportunities in the future. There can be no assurance that the two pending
acquisitions will be completed on a timely basis or at all, nor that the Company
will be able to identify additional acquisition opportunities or complete any
future acquisition transactions. Future acquisitions by the Company may result
in potentially dilutive issuances of equity securities, the incurrence of debt,
write-off of purchased in-process research and development and amortization of
goodwill and other intangible assets, which could materially adversely affect
the Company's operating results. In addition, completed acquisitions present a
number of significant risks and uncertainties, including: the risks that the
Company will not be able to retain the employees or business relationships of
the acquired company or otherwise effectively integrate the operations of the
acquired company with those of the Company; the risk that the Company will fail
to realize any synergies or other cost reduction objectives expected from the
acquisition; the risks that pursuing acquisition opportunities and integrating
acquired products, technologies or companies may distract management from
performing their regular responsibilities; difficulties in the assimilation of
the operations, products and personnel of the acquired company; risks of
entering markets in which the Company has no direct prior experience; and, with
respect to the acquisition of operations located at any significant distance
from the Company's primary facilities, the risks and additional costs associated
with managing geographically disparate operations. There can be no assurance
that the Company will ever successfully complete an acquisition or that any such
acquisition will result in benefits to the Company. See "--Integration of Global
Locations."
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
addition, a significant portion of the Company's contract manufacturing occurs
in Singapore. 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 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.
15
<PAGE> 17
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 Company currently
sources its products through three contract manufacturers in Europe and Asia. In
the event any of the Company's 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 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
16
<PAGE> 18
manufacturing process and increase overall production costs. Due to the
substantial concentration of the Company's manufacturing operations in
Singapore, a disruption of operations at its contractor's facilities there could
have a material adverse effect on the Company's business and operating results.
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 many of the components for use in its SwapSmart and SwapBox
products from Intellicard Systems, a Singapore-based supplier, and 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.
17
<PAGE> 19
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 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 79% of the Company's revenues in 1995, 1996, 1997, and the first three
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, the
Company's operating results are subject to significant fluctuations based upon
changes in the exchange rates of certain currencies, particularly the German
mark, 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.
18
<PAGE> 20
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 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 entries in the date code field. These date 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
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<PAGE> 21
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.
POTENTIAL VOLATILITY OF STOCK PRICE
The stock market has recently experienced significant price and volume
fluctuations unrelated to the operating performance of particular companies. In
addition, the market price of the Company's Common Stock has been highly
volatile and is likely to continue to be so. Factors such as variations in the
Company's financial results, comments by security analysts, the Company's
ability to increase its manufacturing capability as required by customer demand,
any loss of key management, announcements of technological innovations or new
products by the Company or its competition, patents or other proprietary rights
or product or patent litigation, may have a significant effect on the market
price of the Company's Common Stock.
20
<PAGE> 22
PART II: OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
27 Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the
quarter ended March 31, 1998.
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<PAGE> 23
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 14, 1998
/s/ JOHN G. NIEDERMAIER
-------------------------------
John G. Niedermaier
Vice President- Finance, Chief Financial
Officer (Principal Financial and Accounting
Officer)
22
<PAGE> 24
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 23,813
<SECURITIES> 34,715
<RECEIVABLES> 7,977
<ALLOWANCES> 195
<INVENTORY> 3,441
<CURRENT-ASSETS> 70,528
<PP&E> 2,514
<DEPRECIATION> 861
<TOTAL-ASSETS> 72,181
<CURRENT-LIABILITIES> 4,371
<BONDS> 0
0
0
<COMMON> 12
<OTHER-SE> 67,797
<TOTAL-LIABILITY-AND-EQUITY> 72,181
<SALES> 7,815
<TOTAL-REVENUES> 7,815
<CGS> 4,916
<TOTAL-COSTS> 4,916
<OTHER-EXPENSES> 2,588
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (728)
<INCOME-PRETAX> 1,039
<INCOME-TAX> 250
<INCOME-CONTINUING> 789
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 789
<EPS-PRIMARY> 0.07
<EPS-DILUTED> 0.07
</TABLE>
