<PAGE> 1
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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 JUNE 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM_________TO _________
COMMISSION FILE NUMBER: 0-22689
------------------------
SCM MICROSYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0444317
STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION IDENTIFICATION NUMBER)
160 KNOWLES DRIVE, LOS GATOS, CA 95032
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE)
(408) 370-4888
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
N/A
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR,
IF CHANGED SINCE LAST REPORT)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. [X] Yes [ ] No
At July 26, 2000, 14,490,313 shares of common stock were outstanding.
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1
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ITEM 1. FINANCIAL STATEMENTS
SCM MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2000 1999 2000 1999
---------- --------- -------- ---------
<S> <C> <C> <C> <C>
Net revenues $ 30,048 $ 26,383 $ 62,120 $ 50,744
Cost of revenues 20,084 19,234 40,190 35,250
-------- -------- -------- --------
Gross profit 9,964 7,149 21,930 15,494
-------- -------- -------- --------
Operating expenses:
Research and development 2,965 2,022 5,686 3,871
Sales and marketing 4,328 2,965 8,199 5,594
General and administrative 3,207 4,595 6,227 6,518
In-process research and development -- 900 -- 900
Other acquisition-related charges -- 1,168 -- 1,168
-------- -------- -------- --------
Total operating expenses 10,500 11,650 20,112 18,051
-------- -------- -------- --------
Income (loss) from operations (536) (4,501) 1,818 (2,557)
Interest and other, net 2,322 1,782 4,104 3,388
-------- -------- -------- --------
Income (loss) before taxes and minority
interest in earnings 1,786 (2,719) 5,922 831
Provision for income taxes (547) (537) (1,788) (1,677)
Minority interest in (earnings) loss of consolidated
subsidiaries 8 -- (209) --
-------- -------- -------- --------
Net income (loss) $ 1,247 $ (3,256) $ 3,925 $ (846)
======== ======== ======== ========
Net income (loss) per share:
Basic $ 0.09 $ (0.23) $ 0.27 $ (0.06)
Diluted $ 0.08 $ (0.23) $ 0.25 $ (0.06)
Shares used in computing income (loss) per share:
Basic 14,447 14,075 14,362 14,067
Diluted 15,677 14,075 15,666 14,067
Comprehensive income (loss):
Net income (loss) $ 1,247 $ (3,256) $ 3,925 $ (846)
Unrealized gain on investment, net of deferred
taxes (1,486) -- (864) --
Foreign currency translation adjustment, net of
deferred taxes (733) (643) (898) (2,124)
-------- -------- -------- --------
Total comprehensive income (loss) $ (972) $ (3,899) $ 2,163 $ (2,970)
======== ======== ======== ========
</TABLE>
See notes to condensed consolidated financial statements.
2
<PAGE> 3
SCM MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
--------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash, cash equivalents and short-term investments $ 104,559 $ 125,409
Accounts receivable, net 39,571 32,215
Inventories 24,719 15,934
Other current assets 9,636 8,836
--------- ---------
Total current assets 178,485 182,394
Property and equipment, net 8,114 6,372
Investments 15,367 13,945
Intangible assets, net 24,867 8,006
Other assets 105 267
--------- ---------
Total assets $ 226,938 $ 210,984
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 17,649 $ 17,679
Accrued expenses 8,124 7,806
Income taxes payable 2,173 4,906
Short-term debt 71 1,512
--------- ---------
Total current liabilities 28,017 31,903
Deferred tax liability 2,636 3,201
Minority interest 435 84
Stockholders' equity:
Capital stock 15 14
Additional paid-in capital 190,761 173,048
Retained earnings (deficit) 2,573 (1,504)
Deferred compensation -- (25)
Other cumulative comprehensive income 2,501 4,263
--------- ---------
Total stockholders' equity 195,850 175,796
--------- ---------
$ 226,938 $ 210,984
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
3
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SCM MICROSYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
( in thousands; unaudited)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
------------------------
2000 1999
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 3,925 $ (846)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Deferred income taxes 598 --
Depreciation and amortization 2,021 1,157
Charge off of in-process research and development -- 900
Write-off impairment charge related to Dazzle acquisition -- 600
Minority interest in earnings of subsidiaries 209 --
Other (218) 328
Changes in operating assets and liabilities:
Accounts receivable (5,184) (681)
Inventories (6,466) (1,922)
Other current assets 2,145 (179)
Accounts payable (3,951) (2,624)
Accrued expenses (181) 1,350
Income taxes payable (2,943) (2,094)
-------- --------
Net cash used in operating activities (10,045) (4,011)
-------- --------
Cash flows from investing activities:
Capital expenditures (2,722) (3,530)
Proceeds from sale of subsidiary 39 --
Purchase of investments (4,584) (2,096)
Business acquired, net of cash received (7,226) 836
Proceeds from maturities of investments 68,187 45,652
Purchases of investments (36,104) (37,022)
-------- --------
Net cash provided by investing activities 17,590 3,840
-------- --------
Cash flows from financing activities:
Payments on line of credit and other current debt (3,950) --
Proceeds from issuance of equity, net 9,119 1,220
-------- --------
Net cash provided by financing activities 5,169 1,220
Effect of exchange rates on cash (616) (583)
-------- --------
Net increase (decrease) in cash 12,098 466
Cash and cash equivalents at beginning of period 45,662 47,177
-------- --------
Cash and cash equivalents at end of period $ 57,760 $ 47,643
======== ========
Supplemental disclosures of cash flow information:
Cash paid for income taxes $ 5,083 $ 3,726
======== ========
Cash paid for interest $ 348 $ 25
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE> 5
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
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 Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the U.S. 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 and six-month period ended June 30,
2000 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2000. For further information, refer to the financial
statements and footnotes thereto included in SCM Microsystems' ("SCM's")
December 31, 1999 annual report on Form 10-K.
2. LONG-TERM INVESTMENTS AND OTHER CURRENT ASSETS
Long-term investments consist of the following (in thousands):
<TABLE>
<S> <C> <C>
Investment in SmartDisk, at fair value .... $ 9,412 $10,234
Investment in ActivCard, at fair value .... 2,244 --
Investment in Spyrus, at cost ............. 3,546 3,546
Other ..................................... 165 165
------- -------
Total ............................. $15,367 $13,945
======= =======
</TABLE>
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 in the
business of securing the internet for high-value data exchanges and transfers.
In March 2000, SCM converted its loans into shares of Spyrus' Series B
convertible preferred stock (see Note 8).
Included in other current assets is a $2,500,000 short-term loan made by
SCM to FAST Multimedia AG in April 2000.
3. INVENTORIES
Inventories consist of (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
-------- ------------
<S> <C> <C>
Raw materials ...... $13,733 $ 9,077
Finished goods ..... 10,986 6,857
------- -------
$24,719 $15,934
======= =======
</TABLE>
5
<PAGE> 6
4. SHORT-TERM DEBT
As of June 30, 2000, short-term debt consisted of a $60,000 convertible
promissory note and $11,000 in other short-term debt. Short-term debt as of
December, 31, 1999 consisted of $1,418,000 in notes payable and $94,000 in other
short-term debt.
As of December 31, 1999, Dazzle Multimedia, Inc. ("Dazzle") had
convertible promissory notes of $1,418,000 with $1,358,000 of notes payable in
June 2000 and the remainder payable in July 2000. In June 2000, Dazzle repaid
$1,168,000 of the notes and $190,000 of the notes with their accrued interest
converted into 117,431 shares of Dazzle's Series B preferred stock. As of June
30, 2000, Dazzle had a convertible promissory note of $60,000.
5. RECENT ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS No.
133"), which defines derivatives, requires that all derivatives be carried at
fair value, and provides for hedge accounting when certain conditions are met.
SFAS No. 133, as amended, is effective for SCM in 2001. SCM does not believe
adoption of this statement will have a material impact on our consolidated
financial position or results of operations.
6. ACQUISITIONS AND DIVESTITURES
Dazzle Multimedia, Inc.
On June 30, 1999, SCM acquired a 51% interest in Dazzle Multimedia,
Inc., a privately held company based in Fremont, California, in a transaction
that was accounted for under the purchase method of accounting. The results of
Dazzle have been consolidated from the date of acquisition.
Microtech International
On June 27, 2000, SCM paid $7,466,000 in cash and issued approximately
98,700 shares of its common stock, valued at $91.19 per share, to the
shareholders of Microtech International ("Microtech"), a privately held company
in North Branford, Connecticut, in exchange for all of the outstanding share
capital of Microtech. Microtech is a provider of digital photography solutions
for the consumer and business markets. The transaction has been accounted for
under the purchase method of accounting and the results of operations of
Microtech have been included in SCM's results of operations since the date of
acquisition. In connection with the acquisition, SCM incurred acquisition costs
of $997,000, of which $210,000 was paid as of June 30, 2000. An additional $5.0
million, in equal amounts of cash and stock, can be paid to Microtech's former
shareholders if Microtech meets certain financial criteria to be measured for
the last six months of 2000 and the first six months of 2001.
A valuation of the intangible assets related to the acquisition is
currently under way and will be completed in the third quarter of 2000. A
summary of the preliminary allocation of the purchase price is as follows (in
thousands):
<TABLE>
<S> <C>
Cash $ 447
Accounts receivable 3,487
Other current assets 3,207
Other assets 466
Goodwill and other intangible assets 17,728
Notes payable (2,555)
Accounts payable (4,642)
Accrued expenses (675)
--------
Total $ 17,463
========
</TABLE>
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Intangible assets from the acquisition approximated $17,728,000 and
represented the excess of the purchase price over the fair value of the tangible
assets acquired less the liabilities assumed. The preliminary purchase price
allocation is based on the assumption that the entire amount of intangible
assets will have a life of five years and will be amortized on a straight line
basis over this period. SCM has not yet completed the valuation of the
intangible assets acquired. When completed, certain amounts identified as
intangible assets may be amortized over periods other than the five year period.
The following summary, prepared on a pro forma basis, combines SCM's
consolidated results of operations with Microtech's results of operations for
the three and six months ended June 30, 2000 and 1999, as if Microtech had been
acquired as of January 1, 1999. The table includes the impact of certain
adjustments including the elimination of intercompany profit and additional
amortization relating to intangible assets acquired (in thousands, except per
share data):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $ 35,861 $ 31,013 $ 75,186 $ 61,420
Net loss $ (2,297) $ (5,053) $ (407) $ (3,910)
Net loss per share:
Basic $ (0.16) $ (0.36) $ (0.03) $ (0.28)
Diluted $ (0.16) $ (0.36) $ (0.03) $ (0.28)
Shares used in per share computations:
Basic 14,542 14,174 14,459 14,166
Diluted 14,542 14,174 14,459 14,166
</TABLE>
Divestiture
In April 2000, SCM sold its interest in Impleo, a UK-based company, for
$39,000 in cash and 24,579 shares of SmartDisk common stock, resulting in a net
gain of $420,000. The gain is included in interest and other, net in the
statement of operations.
7. SEGMENT REPORTING, GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS
Summary information by segment as of and for the three and six months
ended June 30, 2000 and 1999, is as follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Digital TV:
Revenues $16,305 $ 8,744 $31,867 $17,698
Gross margin 5,529 2,895 11,533 6,032
Digital Media and Connectivity:
Revenues $10,493 $13,856 $21,810 $26,265
Gross margin 3,023 2,571 6,655 6,522
PC/Network Security:
Revenues $ 3,250 $ 3,783 $ 8,443 $ 6,781
Gross margin 1,412 1,683 3,742 2,940
</TABLE>
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<PAGE> 8
Geographic revenues are based on the country where the customers are
located. Information regarding revenues by geographic region as of and for the
three months and six months ended June 30, 2000 and 1999 follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
United States $12,938 $11,081 $28,896 $20,489
Europe 11,696 12,928 23,100 23,376
Asia-Pacific 5,414 2,374 10,124 6,879
------- ------- ------- -------
$30,048 $26,383 $62,120 $50,744
======= ======= ======= =======
</TABLE>
No customer exceeded 10% of total net revenues for the three and six
months ended June 30, 2000. Two customers accounted for 14% and 12% of total net
revenues during the three months ended June 30, 1999. The same two customers
accounted for 14% and 13% of total net revenues during the six months ended June
30, 1999.
8. RELATED PARTY TRANSACTIONS
In 1999, SCM loaned $3,550,000 to Spyrus, Inc., an original equipment
manufacturer ("OEM") customer which provides Internet identification and
encryption solutions for e-business. In March 2000, Spyrus consummated a
$20,150,000 preferred stock financing. In this transaction, SCM acquired
35,500,000 shares of Spyrus' Series B preferred stock at a price of $0.10 per
share through the conversion of the loan. This represents approximately 15.8% of
Spyrus' outstanding common stock on an as converted basis. In connection with
this transaction, three directors of SCM acquired additional Spyrus Series B
preferred stock on the same terms as SCM. Shares held by these individuals
represent approximately 3.6% of Spyrus' outstanding common stock on an as
converted basis. SCM has the right to appoint a director to Spyrus' board of
directors and a member of SCM's Board currently serves as SCM's appointee.
9. SUBSEQUENT EVENT
On July 18, 2000, Dazzle, a 51% owned subsidiary of SCM, completed its
acquisition of the Personal Video Division ("PVD") of FAST Multimedia AG
("FAST"), a developer of digital video production hardware and software for
professional markets, headquartered in Munich, Germany. The transaction will be
accounted for under the purchase method of accounting. Under the terms of the
agreement, Dazzle acquired FAST's PVD and all the assets of the PVD division,
including its research and development, marketing, sales, distribution and
administrative operations. Dazzle paid FAST approximately $4,000,000 in cash for
the division. Up to 2.8 million shares of Dazzle common stock, presently valued
at approximately $4,000,000, could be issued to PVD if the division meets
certain financial performance criteria over the next year.
Acquisition costs for FAST's PVD are estimated to be $380,000. A
valuation of the assets acquired is currently under way and will be finalized in
the third quarter of 2000. The estimated life of the intangible assets is five
years.
8
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements that
involve risks and uncertainties. SCM's actual results could differ materially
from those anticipated in these forward-looking statements as a result of
certain factors, including those set forth in this section as well as those
discussed under the caption "Factors That May Affect Future Operating Results"
and elsewhere in this document.
OVERVIEW
SCM Microsystems designs, develops and sells hardware, software and
silicon that enables people to conveniently and securely access digital content
and services, including content and services that have been protected through
digital encryption. We sell our products primarily into the Digital Television,
Broadband Access, PC/Network Security and Digital Media Transfer markets. Our
target customers are manufacturers in the consumer electronics, computer,
digital appliance, digital media and conditional access system industries. We
sell and license our products through a direct sales and marketing organization,
primarily to original equipment manufacturers. We also sell through
distributors, value added resellers and systems integrators worldwide.
Operationally, we have organized our business around three divisions: Digital
Television and Broadband Access, PC/Network Security, and Digital Media and
Connectivity. We were organized in Delaware in 1996.
ACQUISITIONS
On June 30, 1999, SCM acquired a 51% interest in Dazzle Multimedia,
Inc., a privately held company based in Fremont, California, in a transaction
that was accounted for under the purchase method of accounting. The results of
Dazzle have been consolidated from the date of acquisition.
On June 27, 2000, SCM paid $7,466,000 in cash and issued approximately
98,700 shares of its common stock, valued at $91.19 per share, to the
shareholders of Microtech International ("Microtech"), a privately held company
in North Branford, Connecticut, in exchange for all of the outstanding share
capital of Microtech. Microtech is a provider of digital photography solutions
for the consumer and business markets. The transaction has been accounted for
under the purchase method of accounting and the results of operations of
Microtech have been included in SCM's results of operations since the date of
acquisition. In connection with the acquisition, SCM incurred acquisition costs
of $997,000, of which $210,000 was paid as of June 30, 2000. An additional $5.0
million, in equal amounts of cash and stock, can be paid to Microtech's former
shareholders if Microtech meets certain financial criteria to be measured for
the last six months of 2000 and the first six months of 2001.
Intangible assets from the acquisition approximated $17,728,000 and
represented the excess of the purchase price over the fair value of the tangible
assets acquired less the liabilities assumed. The preliminary purchase price
allocation is based on the assumption that the entire amount of intangible
assets will have a life of five years and will be amortized on a straight line
basis over this period. SCM has not yet completed the valuation of the
intangible assets acquired. When completed, certain amounts identified as
intangible assets may be amortized over periods other than the five year period.
RESULTS OF OPERATIONS
Net Revenues. Net revenues reflect the invoiced amount for goods shipped
less an allowance for estimated returns. Revenue is recognized upon product
shipment. Net revenues for the quarter ended June 30, 2000 were $30.0 million
compared to $26.4 million in 1999, an increase of 14%. For the first six months
of 2000, net revenues were $62.1 million compared to the $50.7 million for the
same period of 1999. The increase in revenues in the first six months of 2000
over the same period in 1999 was due primarily to an increase in sales of our
Digital TV and Broadband Access products of $14.2 million, which was offset by
decreases in sales of Digital Media and Connectivity products of $4.5 million
and in sales of PC/Network Security products of $1.7 million. The increase in
the second quarter of 2000
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<PAGE> 10
compared to the same quarter in 1999 was primarily due to an increase in sales
of our Digital TV and Broadband Access products of $7.6 million, which was
offset by decreases in sales of Digital Media and Connectivity products of $3.4
million and sales of PC/Network Security products of $0.5 million. The increases
in Digital TV and Broadband Access sales primarily consisted of shipments of
Dazzle products to its customers and of our new St@rKey(R) product. No Dazzle
product sales were included in the first six months of 1999 since it was
acquired on June 30, 1999. The decrease in Digital Media and Connectivity sales
was primarily due to the lack of availability of multimedia flash memory cards
for the digital music player market in 2000 and the reduction of demand in that
segment of the market due to uncertainties related to the future of digital
music downloaded from the Internet. The decrease in PC/Network Security
shipments was primarily due to a reduction of sales to the U.S. government in
2000.
Gross Profit. Gross profit for the second quarter of 2000 was $10.0
million, or 33% of total net revenues, compared to $7.1 million, or 27% for the
same quarter of 1999. Gross profit for the first six months of 2000 was $21.9
million, or 35% of total net revenues compared to $15.5 million, or 31% of total
net revenues for the same period of 1999. The increase in gross profit in
absolute dollars for the second quarter and first six months of 2000 was
primarily due to the aforementioned increase in shipments of Digital TV and
Broadband Access products in both periods and PC/Network Security products for
the first quarter of 2000 which carry gross profit levels that are higher than
our Digital Media and Connectivity products. Digital Media and Connectivity
margins in the second quarter and six month period in 1999 also included a $1.1
million charge resulting from a write down of excess inventory in SCM's Digital
Media and Connectivity division and costs associated with the ramp up of
production of certain Digital Media and Connectivity products in the second
quarter of 1999. The write down of inventory resulted from a review of SCM's
products in the Digital Media and Connectivity division, which was conducted
following a slow down in sales of certain products. These declining sales were
attributed to an overlap in SCM's product lines. The increase as a percentage of
total net revenues was due primarily to the change in product mix discussed
above and the inclusion of the $1.1 million charge in the 1999 periods
presented. We believe that our gross profit in absolute dollars during 2000 will
continue to be above the levels experienced in 1999. Our gross profit has been
and will continue to be affected by a variety of factors, including competition,
product configuration and mix, the availability of new products, product
enhancements, software and services, and the cost and availability of
components. Accordingly, gross profit percentages are expected to fluctuate from
period to period.
Research and Development. Research and development expenses consist
primarily of employee compensation and prototype expenses. To date, the period
between achieving technological feasibility and completion of software has been
short, and software development costs qualifying for capitalization have been
insignificant. Accordingly, SCM has not capitalized any software development
costs. For the second quarter of 2000, research and development expenses were
$3.0 million, compared with $2.0 million in the same quarter of 1999, an
increase of 47%. For the first six months of 2000, research and development
expenses were $5.7 million, compared with $3.9 million, an increase of 47%. As a
percentage of total net revenues, research and development expenses were 10% in
the second quarter of 2000, 9% for the first six months of 2000 and 8% for the
corresponding 1999 periods. The increase in absolute amounts was primarily due
to increased engineering headcount and related product development costs at our
development centers in France and India, and to research and development
expenses of Dazzle. Personnel related expenses increased by $0.7 million and
prototype expenses increased $0.1 million in the second quarter of 2000 compared
to the same quarter in 1999. Personnel related expenses increased by $1.3
million and prototype expenses increased by $0.2 million in the first six months
of 2000 compared to the same period in 1999. We believe that the absolute amount
of research and development expenses during 2000 will be higher than in 1999 due
to a higher number of personnel involved in our new product development and
customer projects, but that such expenses will fluctuate as a percentage of
total net revenues.
Sales and Marketing. Sales and marketing expenses consist primarily of
employee compensation and trade show and other marketing costs. Sales and
marketing expenses for the second quarter of 2000 were $4.3 million, or 14% of
revenues, compared with $3.0 million in the second quarter of 1999, or 11% of
revenues, an increase of 46%. Sales and marketing expenses for the first six
months of 2000 were $8.2 million, or 13% of revenues, compared with $5.6
million, or 11% of revenues, in the same period of 1999, an increase of 47%.
These increases in absolute amounts in 2000 were primarily due to the
acquisition of Dazzle and an increase in sales and marketing costs in the U.S.
and Germany. The increases in the second quarter of 2000 compared to the same
period in 1999 consisted primarily of personnel related expenses of $0.3
million, external and internal sales commissions of $0.2 million, marketing
program costs of $0.5 million and depreciation costs of $0.1 million. In the
first six months of 2000 compared to the same period in 1999, increases in
spending were primarily from personnel related expenses of $0.9 million,
marketing program costs of $0.7 million, external and internal sales commissions
of $0.4 million and
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<PAGE> 11
depreciation expenses of $0.2 million. We expect sales and marketing expenses in
2000 to increase in absolute amounts as we continue to expand our sales and
business development efforts on a worldwide basis.
General and Administrative. General and administrative expenses consist
primarily of compensation expenses for employees performing SCM's administrative
functions, professional fees such as legal, audit, tax and consulting fees, and
the amortization of intangible assets. In the second quarter of 2000, general
and administrative expenses were $3.2 million, a decrease of 30% compared with
$4.6 million in the second quarter of 1999, and representing 11% and 17% of
total net revenues in the second quarter of 2000 and 1999, respectively.
Increases in the second quarter of 2000 as compared to the same period in 1999
of $0.4 million in personnel related expenses, $0.2 million in amortization
expense, and $0.2 million in professional fees were more than offset by the
reversal of a $2.0 million reserve for bad debt for one of our customers who was
experiencing cashflow difficulties in the second quarter of 1999. For the
six-month period in 2000, general and administrative expenses totaled $6.2
million, a decrease of $0.3 million from the same period of 1999. Increases in
expenses as compared to the same period of 1999 were $0.6 million for personnel
related expenses, $0.5 million for amortization expense, and $0.6 million for
professional fees, offset by the $2.0 million charge taken in the second quarter
of 1999 described above. The increases in professional fees were primarily
related to tax consulting and the roll-out of our SAP software worldwide. The
increases in intangible asset amortization and in personnel expenses were
primarily due to the acquisition of Dazzle. We believe general and
administrative expenses in 2000 will continue to increase in absolute amount as
we continue to improve our infrastructure, but will fluctuate as a percentage of
total net revenues.
In-Process Research and Development. The aggregate fair value of
Dazzle's research and development efforts that had not reached technological
feasibility at the acquisition date of June 30, 1999 and, as of that date, had
no alternative future uses was determined by independent appraisal to be
approximately $0.9 million, and was expensed at the acquisition date.
Other Acquisition-Related Charges. In connection with the acquisition of
a majority interest in Dazzle, SCM incurred a non-recurring charge of $0.6
million resulting from the write down of the Dazzle investment at the date of
the acquisition, headcount termination costs of $0.3 million and other costs of
$0.2 million.
Interest Income and Other, Net. Interest income and other, net consists
of interest earned on invested cash, offset by interest paid or accrued on
outstanding debt, foreign currency gains or losses and, in the second quarter of
2000, a net gain of $0.4 million on the sale of a subsidiary. In the second
quarter of 2000, the net gain on the sale of investments was $0.4 million.
Interest income and other, net, was $1.5 million and foreign currency gains were
$0.4 million, compared to $1.7 million for interest income and other, net and
foreign currency gains of $0.1 million in the same period in 1999. For the first
six months of 2000, the net gain on the sale of investments was $0.4 million,
interest income and other, net was $3.2 million and the foreign currency gain
was $0.5 million compared to interest income and other, net of $3.2 million and
a foreign currency gain of $0.2 million in the same period of 1999. The decrease
in interest income and other, net in the second quarter of 2000 compared to 1999
is primarily due to lower interest income on lower cash balances during the
second quarter of 2000.
Income Taxes. The provision for income taxes in the first six months of
2000 was $1.8 million, or 30% of income before tax, compared to 33% for all of
1999. SCM's tax rate is affected by the mix of taxable income among the various
tax jurisdictions in which we do business and the non-deductibility of various
one-time charge and intangibles.
Minority interest. Minority interest reflects the proportional profits
or losses that are attributable to the minority shareholders in two of SCM's
majority owned subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 2000, our working capital was $149.9 million, compared to
working capital of $150.5 million as of December 31, 1999.
During the first six months of 2000, cash and cash equivalents increased
by $12.1 million due primarily to $17.6 million provided by investing activities
and $5.2 million by financing activities being offset by a use of cash of $10.0
million in operations. The cash provided by investing activities was primarily
from net proceeds of $32.1
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million from short-term investments, offset by $7.2 million (net of cash
acquired) paid to purchase Microtech, the purchase of $4.6 million of
investments and $2.7 million of capital expenditures. The $5.2 million of cash
provided by financing activities was from proceeds from the exercise of stock
options of $9.1 million offset by $4.0 million of debt repayment. Cash used in
operations of $10.0 million was primarily from increases in inventories of $6.5
million and accounts receivable of $5.2 million, and decreases in accounts
payable of $4.0 million and income taxes payable of $2.9 million, more than
offsetting income from operations of $3.9 million, which includes depreciation
and amortization of $2.0 million.
SCM has revolving lines of credit with two banks in Germany providing
total borrowings of up to DM 3,000,000 (approximately $1,464,000 as of June 30,
2000). Neither line has an expiration date. The German lines of credit bear
interest at rates ranging from 6.75% to 11.25%, and borrowings under these lines
of credit are unsecured. In the United States, we have an unsecured $3,000,000
line of credit which bears interest at 8.5% and expires in May 2001. In
addition, we have a Singapore $1,200,000 (approximately $695,000 as of June 30,
2000) overdraft facility with a local bank due on demand. The Singapore line is
secured by a U.S. $380,000 fixed deposit and has a base interest rate of 6.5%.
Japan also has a 67 million yen (approximately $631,000 as of June 30, 2000)
line of credit with a local bank that is renewed annually for one year each
June. The Japanese line has an interest rate of 1.625% and is secured by a 67
million yen deposit. At June 30, 2000, no amounts were outstanding under any of
our lines of credit.
We believe that our current capital resources and available borrowings
should be sufficient to meet our operating and capital requirements through at
least the end of 2000. We may, however, seek additional debt or equity financing
prior to that time. We can not assure you that additional capital will be
available to SCM on favorable terms or at all. The sale of additional debt or
equity securities may cause dilution to existing stockholders.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing SCM. Additional risks and uncertainties not presently known to
us or that we currently deem immaterial may also impair our business operations.
If any of the following risks actually occur, our business, financial
condition or results of operations could be materially adversely affected. In
such case, the trading price of our common stock could decline and you could
lose all or part of your investment.
WE HAVE INCURRED OPERATING LOSSES AND MAY NOT REMAIN PROFITABLE.
Although SCM was profitable for the quarters ended June 30, 2000, March
31, 2000, December 31, 1999, September 30, 1999 and March 31, 1999 and for the
year ended December 31, 1997, we incurred net losses on an annual basis from our
inception in 1993 through the year ended December 31, 1996, as well as in 1998.
We also incurred a net loss in the quarter ended June 30, 1999. As of June 30,
2000, SCM had accumulated earnings of $2.6 million. In view of our loss history,
we cannot assure you that we will be able to achieve or sustain profitability on
an annual or quarterly basis in the future.
Our quarterly operating results depend on a number of factors that are
difficult to forecast. If our future quarterly operating results fall below the
expectations of securities analysts or investors, the trading price of our
common stock will likely drop. Our quarterly operating results have fluctuated
in the past and may continue to fluctuate in the future as a result of many
factors, including:
- size, timing, cancellation or rescheduling of significant orders;
- availability of key components or products in the market on which sales of
our product depend;
- new product announcements or introductions by us or our competitors;
- our ability to develop, introduce and market new products and product
enhancements on a timely basis, if at all;
- our success in expanding our sales and marketing organization and programs;
- technological changes in the market for our products;
- our level of expenditures on research and development; and
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- general economic trends.
In addition, because a high percentage of our operating expenses are
fixed, a small variation in revenue can cause significant variations in our
operating results from quarter to quarter. SCM's operating results may vary
significantly in future periods and our historical results may not be a reliable
indicator of our future performance.
SEASONAL TRENDS IN SALES OF OUR PRODUCTS MAY AFFECT OUR QUARTERLY OPERATING
RESULTS.
Our business and operating results reflect seasonal trends. We have
typically experienced lower net revenue and operating income in the first
quarter and second quarter and higher net revenue in the third quarter and
fourth quarter of each calendar year. We believe that the seasonal trends in our
business and operating results are primarily due to two factors. The first is
the retail selling cycles of our OEM customers in our Digital Media Transfer,
Digital TV and Broadband Access markets, which are typically stronger in the
second half of the calendar year. SCM sells readers for digital cameras and
Internet music players in the U.S. and digital video broadcasting products in
Europe. Because OEMs typically bundle our devices into their consumer products,
and because the market for consumer products is stronger in the second half of
the year, our business is impacted as well. We expect that our sales to
consumer-oriented OEMs will increase, and the seasonal trends that effect our
business and operating results will continue. The second factor is related to
the budgeting cycle of the U.S. government, which is heavily weighted to the
second half of the calendar year. Because OEMs incorporate our data security
products into PCs and workstations that are then sold to the U.S. government,
the government's budget cycle influences the dynamics of our business as well.
OUR TARGET MARKETS MAY NOT ACCEPT OUR PRODUCTS.
SCM's future growth and operating results will depend on whether our
products are commercially successful. As described below, each of our product
families address needs in different emerging markets. We may not succeed in
these emerging markets. In addition, as these markets develop, industry
standards may be established. Our products may not comply with the industry
standards ultimately adopted in these emerging markets.
We sell security and connectivity products across four target markets:
Digital TV, Broadband Access, PC/Network Security and Digital Media Transfer. In
the Digital Media Transfer market, our reader and connectivity products provide
easy to use, high-speed connections between digital platforms, such as PCs and
digital cameras, and electronic media, such as copyright-protected music from
the Internet. If the benefits of rapid transfer of digital photographs or music
are not perceived as sufficient, or if alternative technologies are more widely
adopted than the use of a media reader, then demand for products such as ours
may not grow.
In the PC/Network Security market, smart card-based security
applications are beginning to be adopted by computer makers and software
providers. Smart card token-based security applications provide protection from
unauthorized access to digital information. Our SwapSmart products are designed
to provide smart card-based security for PCs. However, the market for network
and electronic commerce security applications is still emerging and the smart
card may not become the industry standard; hence other token architectures or
other security approaches may be selected for these applications.
In the Digital TV market, our products provide a means of controlling
access to digital television broadcasts. Our DVB-CAM products provide
conditional access functionality while adhering to the European DVB-CI and U.S.
NRSS-B standards. To date, our DVB-CAM products have been implemented in a
relatively limited number of Digital TV set-top boxes in Europe. However, the
European standard for Digital TV conditional access applications is still
emerging. Although we believe that the DVB-CI standard will eventually become
the European standard for Digital TV conditional access applications, this
standard may not be adopted and the European Digital TV market may fail to
develop further. In the United States, the market for Digital TV conditional
access products has only recently begun to develop and may not grow. In
addition, the substantial base of proprietary analog set-top boxes already
installed in the U.S. may cause the market for Digital TV conditional access
products in general, and our products in particular, to grow more slowly than
expected or not at all.
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In the market for Broadband Access, our products provide a means of
accessing high-bandwidth content on the PC utilizing the broadband satellite,
terrestrial and cable networks. If other solutions address this demand more
quickly, more cost effectively or more conveniently than our products, or if we
are unable to development sufficient relationships with partners to distribute
our products, then our Broadband Access business may not grow.
If the market for the products described above or any of our other
products fail to develop or develop more slowly than expected, or if any of the
standards supported by us do not achieve or sustain market acceptance, our
business and operating results would be materially and adversely affected.
WE DEPEND UPON SALES TO ORIGINAL EQUIPMENT MANUFACTURERS AND DISTRIBUTORS.
Most of our products are intended for use as components subsystems or
value-added devices in systems manufactured and sold by third party original
equipment manufacturers, or OEMs. In order to convince an OEM to incorporate our
products into its systems, we must demonstrate that our products provide
significant commercial advantages over alternative solutions. We may fail to
successfully demonstrate these advantages or our products may cease to provide
any advantages. Even if we are able to demonstrate that our products are
superior, OEMs may still choose not to incorporate our products into their
systems. OEMs may also change their business strategies and manufacturing
practices, which could cause them to purchase fewer units of our products, find
other sources for products we currently manufacture or manufacture these
products internally. Our OEM customers may also seek price concessions from us.
Failure of OEMs to incorporate our products into their systems, the failure of
such OEMs' systems to achieve market acceptance or any other event causing a
decline in our sales to OEMs would have a material adverse effect on our
business and operating results.
Sales of some of our Digital Media and Connectivity and PC/Network
Security products are made to distributors, some of whom are smaller companies
with limited working capital for marketing and promotion efforts and whose cash
flow is dependent on payment from their customers. We believe that delays in
shipments by and payments to our distribution customers by their customers may
have a material adverse effect on our business and operating results.
A SIGNIFICANT PORTION OF OUR SALES COMES FROM A SMALL NUMBER OF CUSTOMERS.
Our products are targeted at OEM consumer electronics, computer, digital
appliance, digital media and conditional access system manufacturers. Sales to a
relatively small number of customers historically have accounted for a
significant percentage of our total sales. Sales to our top 10 customers
accounted for approximately 47% of our total net revenues in the second quarter
of 2000. No customer exceeded 10% of our revenues in the second quarter and for
the first six months of 2000. We expect that sales of our products to a limited
number of customers will continue to account for a high percentage of our total
sales for the foreseeable future. The loss or reduction of orders from a
significant customer, including losses or reductions due to manufacturing,
reliability or other difficulties associated with our products, changes in
customer buying patterns, or market, economic or competitive conditions in the
digital information security business, could harm our business and operating
results.
WE RELY ON OUR STRATEGIC RELATIONSHIPS TO GENERATE REVENUE.
SCM collaborates with a number of corporations and is a member of key
industry consortia. Our future success will depend significantly on the success
of our current arrangements and our ability to establish additional
arrangements. We have formed strategic relationships, including
technology-sharing agreements, with a number of key industry players such as
Intel, Microsoft, Ericsson, Nokia and SanDisk. We evaluate, on an ongoing basis,
potential strategic alliances and intend to continue to pursue such
relationships. These arrangements may not result in commercially successful
products.
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OUR SALES TO GOVERNMENT CONTRACTORS ARE SUBJECT TO UNCERTAINTIES AND MAY
DECREASE.
Approximately 2%, 8%, 12% and 17% of our net revenues for the six
months ended June 30, 2000 and the years ended 1999, 1998 and 1997,
respectively, were derived from sales of our SwapBox product for use by the U.S.
government. These sales were made under contracts between SCM and major OEMs
that sell PCs to the United States Department of Defense ("DOD"). We believe
that indirect sales to the DOD are subject to a number of significant
uncertainties, including timing and availability of funding, unpredictable
changes in the timing and quantity of orders and the generally competitive
nature of government contracting. Furthermore, the DOD has been reducing total
expenditures over the past few years in several areas. Accordingly, funding for
the purchase of our products may be reduced in the future. In addition, we may
not be able to modify existing products or develop new products that will
continue to meet the specifications of OEM suppliers to the DOD. A significant
loss of indirect sales to the U.S. government would have a material adverse
effect on our business and operating results. For example, in the second quarter
ended June 30, 2000, sales of our SwapBox product were impacted by a reduction
in orders from OEM's selling to the U.S. DOD.
OUR MARKETS ARE HIGHLY COMPETITIVE.
The market for our products is intensely competitive and characterized
by rapidly changing technology. We believe that competition in this market is
likely to intensify as a result of increasing demand for digital data security,
access control and connectivity products. We currently experience competition
from a number of sources, including:
- Motorola/General Instrument, PubliCard and Scientific Atlanta in DVB-CAM
modules;
- Pinnacle Systems in digital video creation;
- Broadlogic, Harmonic, Motorola, Terayon and Thomson Multimedia in broadband
PC receivers;
- ActionTec, Carry Computer Engineering, Greystone and Litronic in PC Card
adapters;
- Gemplus, Litronic, PubliCard and Towitoka in smart card readers and
universal smart card reader interfaces; and
- Carry Computer Engineering, DataFab and SmartDisk for digital media readers
and connectivity.
We also experience indirect competition from some of our customers which
sell alternative products or are expected to introduce competitive products in
the future. We may in the future face competition from these competitors and new
competitors, such as Motorola, that develop digital information security
products. In addition, the market for digital data security, access control and
connectivity products may ultimately include technological solutions other than
ours.
Many of our current and potential competitors have significantly greater
financial, technical, marketing, purchasing and other resources. As a result,
our competitors may be able to respond more quickly to new or emerging
technologies or standards and to changes in customer requirements. Our
competitors may also be able to devote greater resources to the development,
promotion and sale of products, and may be able to deliver competitive products
at a lower end user price. Current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties
to increase the ability of their products to address the needs of our
prospective customers. Therefore, it is possible that new competitors or
alliances among competitors may emerge and rapidly acquire significant market
share. Increased competition is likely to result in price reductions, reduced
operating margins and loss of market share. Any of these factors could have a
material adverse effect on our business and operating results.
We believe that the principal competitive factors affecting the market
for digital data security and connectivity products include:
- the extent to which products comply with existing industry standards;
- technical features;
- ease of use;
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- quality and reliability;
- level of security;
- strength of distribution channels; and
- price.
We may not be able to successfully compete as to these or other factors and the
competitive pressures may cause our business and operating results to suffer.
ANY DELAYS IN OUR NORMALLY LENGTHY SALES CYCLE COULD RESULT IN SIGNIFICANT
FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS.
When we obtain a new OEM customer, our initial sales to that customer
usually take six to nine months. During this sales cycle, we may expend
substantial financial resources and our management's time and effort with no
assurance that a sale will ultimately result. The length of a new OEM customer's
sales cycle depends on a number of factors that we may not be able to control.
These factors include the customer's product and technical requirements and the
level of competition we face for that customer's business. Any delays in the
sales cycle for new customers could have a material adverse effect on our
business and operating results.
WE HAVE EXPERIENCED SIGNIFICANT GROWTH IN OUR BUSINESS IN RECENT PERIODS AND WE
MAY NOT BE ABLE TO MANAGE THIS GROWTH OR ANY FUTURE GROWTH..
Our business has grown substantially in recent periods, with net
revenues increasing from $10.9 million in 1994 to $127.3 million 1999 and
revenues of $62.1 million in the first six months of 2000. We have expanded our
focus from the PC/Network Security market to include Digital TV, Digital Media
Transfer and more recently Broadband Access. Managing business in each of these
markets requires skilled management, significant attention and substantial
resources. To address our need for additional resources and because of
acquisitions, we have increased in size from 67 employees at December 31, 1995
to 471 employees as of June 30, 2000. The growth of our business places a
significant strain on our management and operations.
If we are successful in achieving our growth plans, our growth is likely
to continue to place a significant burden on our operating and financial systems
and increased responsibility for senior management and other personnel. Existing
management or any new members of management may not be able to improve existing
systems and controls or implement new systems and controls in response to
anticipated growth. Our failure to do so could have a material adverse effect on
our business and operating results.
WE ARE CONSOLIDATING A MAJORITY OWNED SUBSIDARY.
Effective June 30, 1999, SCM purchased 51% of Dazzle Multimedia Inc.,
which will continue to be operated as a separate entity. Although SCM has a
majority of the voting stock of Dazzle, has representation on the board of
directors and is financing the company, our control of Dazzle is subject to our
fiduciary duty to its minority shareholders. Consequently, the decisions we make
on behalf of Dazzle may not always not be in line with our goals for SCM. This
could have a significant impact on the operations of Dazzle and consequently
SCM.
The financial results of Dazzle are being consolidated in SCM's results.
Dazzle has been profitable in each quarter since its acquisition, and SCM has
and will continue to recognize in our consolidated financial results that
portion of Dazzle profit that is attributable to the minority shareholders.
OUR GLOBAL LOCATIONS MUST WORK TOGETHER EFFECTIVELY.
SCM's U.S. headquarters are located in Los Gatos, California. European
headquarters are located in Pfaffenhofen, Germany. We have sales offices in
Wokingham, England, and research and development facilities in
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La Ciotat, France and Pondicherry and Madras, India. In Asia, we have
manufacturing facilities in Singapore and sales offices in Taiwan and Tokyo,
Japan. Operating in diverse geographic locations imposes a number of risks and
burdens on us, including the need to manage employees and contractors from
diverse cultural backgrounds and who speak different languages, and difficulties
associated with operating in a number of time zones. Although these difficulties
can be reduced through the use of electronic mail and teleconferencing,
unforeseen difficulties or logistical barriers in operating in diverse locations
may occur. Operating in widespread geographic locations requires us to implement
and operate complex information and operational systems. Although we believe
that our systems are adequate, in the future we may have to implement new
systems. Implementation of new information systems, in particular, may be
costly. Any failure or delay in implementing needed systems, procedures and
controls on a timely basis or in expanding current systems in an efficient
manner could have a material adverse effect on our business and operating
results.
WE MAY BE EXPOSED TO RISKS OF INTELLECTUAL PROPERTY INFRINGEMENT.
SCM's success depends significantly upon our proprietary technology. We
currently rely on a combination of patent, copyright and trademark laws, trade
secrets, confidentiality agreements and contractual provisions to protect our
proprietary rights. Our software, documentation and other written materials are
protected under trade secret and copyright laws, which afford only limited
protection. SCM generally enters into confidentiality and non-disclosure
agreements with our employees and with key vendors and suppliers. For example,
our SwapBox and SwapSmart trademarks are registered in the United States. We
continuously evaluate the registration of additional trademarks as appropriate.
We currently have seven United States patents issued and five European patents
issued. We also have nineteen patent applications pending worldwide. In
addition, we have exclusive licenses under four other United States patents, and
licenses for two United States patents associated with our products. Although we
often seek to protect our proprietary technology through patents, it is possible
that no new patents will be issued, that our proprietary products or
technologies are not patentable, and that any issued patent will fail to provide
us with any competitive advantages.
There has been a great deal of litigation in the technology industry
regarding intellectual property rights. Litigation may be necessary to protect
our proprietary technology. SCM has from time to time received claims that it is
infringing upon third parties' intellectual property rights and future disputes
with third parties may not be resolved on terms acceptable to us. As the number
of products and competitors in our target markets grows, the likelihood of
infringement claims also increases. Any claims or litigation may be
time-consuming and costly, cause product shipment delays, or require us to
redesign our products or require us to enter into royalty or licensing
agreements. Any of these events could have a material adverse effect on our
business and operating results. Despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy aspects of our products or to
use our proprietary information and software. In addition, the laws of some
foreign countries do not protect proprietary and intellectual property rights to
as great an extent as do the laws of the United States. Our means of protecting
our proprietary and intellectual property rights may not be adequate. There is a
risk that our competitors will independently develop similar technology,
duplicate our products or design around patents or other intellectual property
rights.
OUR BUSINESS COULD SUFFER IF WE OR OUR CONTRACT MANUFACTURERS CANNOT MEET
PRODUCTION REQUIREMENTS.
We are designing and manufacturing new products and technologies to
address emerging markets that are early in their life cycles. In many cases our
products are the first of their kind to address the evolving business
requirements of our customers. While we perform initial beta testing on all our
products, in certain cases we are unable to test the efficacy of the design or
functionality of our products for mass production. If we are successful in
securing large contracts for our products, we cannot be certain that we will be
able to produce them in sufficient quantities and that they will meet customer
specifications.
In addition, most of our products are manufactured outside the United
States because we believe that global sourcing enables us to achieve greater
economies of scale, improve gross margins and maintain uniform quality standards
for our products. Any significant delay in our ability to obtain adequate
supplies of our products from our current or alternative sources would
materially and adversely affect our business and operating results. In an effort
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to reduce our manufacturing costs, SCM has shifted volume production of many of
our product components to our wholly owned subsidiary in Singapore. In addition,
we utilize contract manufacturers in Europe and Asia. Foreign manufacturing
poses a number of risks, including transportation delays and interruptions,
difficulties in staffing, currency fluctuations, potentially adverse tax
consequences and unexpected changes in regulatory requirements, tariffs and
other trade barriers, and political and economic instability. If we or any of
our contract manufacturers cannot meet our production requirements, we may have
to rely on other contract manufacturing sources or identify and qualify new
contract manufacturers. Despite efforts to do so, we may not be able to identify
or qualify new contract manufacturers in a timely manner and these new
manufacturers may not allocate sufficient capacity to us in order to meet our
requirements.
WE HAVE A LIMITED NUMBER OF SUPPLIERS OF KEY COMPONENTS.
We rely upon a limited number of suppliers of several key components of
our products. For example, SCM purchases mechanical components for use in our
smart card reader product exclusively from Stocko, a German-based supplier. Our
reliance on only one supplier could impose several risks, including an
inadequate supply of components, price increases, late deliveries and poor
component quality. Disruption or termination of the supply of these components
could delay shipments of our products, which could have a material adverse
effect on our business and operating results. These delays could also damage
relationships with current and prospective customers.
THE MARKETS FOR OUR PRODUCTS MAY UNDERGO RAPID TECHNOLOGICAL CHANGE AND OUR
FUTURE SUCCESS WILL DEPEND ON OUR ABILITY TO MEET THE SOPHISTICATED NEEDS OF OUR
CUSTOMERS.
The markets for our products are characterized by rapidly changing
technology. Our customers' needs change and new products are introduced
frequently. Product life cycles are short and industry standards are still
evolving. These rapid changes in technology could render our existing products
obsolete and unmarketable. Therefore, our future success will depend upon our
ability to successfully develop and introduce new and enhanced products that
meet our customers' increasing expectations and incorporate the latest
technology. Product development is risky because it is difficult to foresee
developments in technology, coordinate technical personnel and identify and
eliminate design flaws. Any significant delay in releasing new products could
have a material adverse effect on the ultimate success of our products and could
reduce sales of predecessor products. We may not be able to introduce new
products on a timely basis. In addition, new products introduced by us may fail
to achieve a significant degree of market acceptance or, once accepted, may fail
to sustain viability in the market for any significant period. These factors
could have a material adverse effect on our business and operating results.
MANY OF OUR CUSTOMERS ARE LOCATED IN OTHER COUNTRIES WHICH EXPOSES OUR BUSINESS
TO RISKS RELATED TO INTERNATIONAL SALES AND CURRENCY FLUCTUATIONS.
SCM was originally a German corporation and continues to conduct a
substantial portion of our business in Europe. Approximately 53%, 52%, 62%, and
51% of our revenues for the six months ended June 30, 2000 and the years ended
1999, 1998, and 1997, respectively, were derived from customers located outside
the United States. Because a significant number of our principal customers are
located in other countries, we anticipate that international sales will continue
to account for a substantial portion of our revenues. As a result, a significant
portion of our sales and operations may continue to be subject to certain risks,
including:
- tariffs and other trade barriers;
- difficulties in staffing and managing disparate branch operations;
- currency exchange risks;
- exchange controls; and
- potential adverse tax consequences.
These factors may have a material adverse effect on our business and operating
results.
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We conduct operations and sell products in several different countries.
Over the last two years, we have acquired companies in Japan, Singapore, Great
Britain and India. Therefore, our operating results may be impacted by the
fluctuating exchange rates of foreign currencies, especially the German mark,
the Japanese yen, the Singapore dollar, the British pound and the Indian rupee,
in relation to the U.S. dollar. We do not currently engage in hedging activities
with respect to our foreign currency exposure. We continually monitor our
exposure to currency fluctuations and may use financial hedging techniques when
appropriate to minimize the effect of these fluctuations. Even so, exchange rate
fluctuations may still have a material adverse effect on our business and
operating results. In the future, we could be required to denominate our product
sales in other currencies, which would make the management of currency
fluctuations more difficult and expose us to greater currency risks.
WE MAY FACE PRODUCT LIABILITY RISKS.
Customers rely on our token-based security products to prevent
unauthorized access to their digital information. A malfunction of or design
defect in our products could result in legal or warranty claims. Although we
place warranty disclaimers and liability limitation clauses in our sales
agreements and maintain product liability insurance, we cannot assure you that
these measures will be effective in limiting our liability. Liability for
damages resulting from security breaches could be substantial and could have a
material adverse effect on our business and operating results. In addition, a
well-publicized security breach involving token-based and other security systems
could adversely affect the market's perception of products like ours in general,
or our products in particular, regardless of whether the breach is actual or
attributable to our products. In that event, the demand for our products could
decline, which would cause our business and operating results to suffer.
OUR KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS AND SUCH KEY PERSONNEL MAY NOT
REMAIN WITH SCM IN THE FUTURE.
We depend on the continued employment of our senior executive officers
and other key management and technical personnel. If any of our key personnel
leave and are not adequately replaced, our business would be adversely affected.
In particular, we depend on the continued service of Steven Humphreys, our
Chairman of the Board, Robert Schneider, our Chief Executive Officer, Bernd
Meier, our President and Chief Operations Officer, and Andrew Warner, our Chief
Financial Officer. SCM provides compensation incentives such as bonuses,
benefits and option grants (which are typically subject to vesting over four
years) to attract and retain qualified employees. In addition, our German
subsidiary has entered into substantially similar employment agreements with
each of Messrs. Schneider and Meier pursuant to which each serves as a Managing
Director of the subsidiary. Each of the respective agreements has no set
termination date, may be terminated by the subsidiary or the officer with nine
months notice, and provides that the officer cannot work for one of our
competitors during the one-year period following his termination. Non-compete
agreements are, however, generally difficult to enforce. Therefore, these
provisions may not provide us with significant protection.
We believe that our future success will depend in large part on our
continuing ability to attract and retain highly qualified technical and
management personnel. Competition for such personnel is intense, and we may not
be able to retain our key technical and management employees or to attract,
assimilate or retain other highly qualified technical and management personnel
in the future.
OUR STOCK PRICE IS POTENTIALLY VOLATILE.
The stock market has recently experienced significant price and volume
fluctuations unrelated to the operating performance of particular companies. In
addition, the market price of our common stock has been highly volatile and is
likely to continue to be volatile. The future trading price for our common stock
will depend on a number of factors, including:
- variations in our financial results;
- comments and forecasts by security analysts;
- our ability to effectively manage our business;
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- expected or announced relationships with other companies;
- any loss of key management;
- announcements of technological innovations or new products by us or our
competition; and
- patents or other proprietary rights or patent litigation.
In the past, companies that have experienced volatility in the market price of
their stock have been the object of securities class action litigation. If we
were the object of securities class action litigation, it could result in
substantial costs and a diversion of management's attention and resources.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
FOREIGN CURRENCIES
We conduct operations and sell products in several different countries.
Therefore, our operating results may be impacted by the fluctuating exchange
rates of foreign currencies, especially the German mark, the Japanese yen, the
Singapore dollar, the British pound and the Indian rupee, in relation to the
U.S. dollar. We do not currently engage in hedging activities with respect to
our foreign currency exposure. We continually monitor our exposure to currency
fluctuations and may use financial hedging techniques when appropriate to
minimize the effect of these fluctuations. Even so, exchange rate fluctuations
may still have a material adverse effect on our business and operating results.
FIXED INCOME INVESTMENTS
SCM's exposure to market risk for changes in interest rates relates
primarily to our investment portfolio. We do not use derivative financial
instruments for speculative or trading purposes. We place our investments in
instruments that meet high credit quality standards, as specified in our
investment policy. The policy also limits the amount of credit exposure to any
one issue, issuer and type of instrument. We do not expect any material loss
with respect to our investment portfolio.
We do not use derivative financial instruments in our investment
portfolio to manage interest rate risk. We do, however, limit our exposure to
interest rate and credit risk by establishing and strictly monitoring clear
policies and guidelines for our fixed income portfolios. At the present time,
the maximum duration of all portfolios is limited to two years. The guidelines
also establish credit quality standards, limits on exposure to one issue,
issuer, as well as the type of instrument. Due to the limited duration and
credit risk criteria established in our investment guidelines, the exposure to
market and credit risk is not expected to be material.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On June 27, 2000, SCM acquired Microtech International, Inc. In
Connection with the acquisition, SCM issued 99,141 shares of its common stock.
The transaction was exempt from registration requirements of Section 5 of the
Securities Act pursuant to Section 4(2) thereof. The recipients of the
securities represented their intentions to acquire the securities for investment
only and not with a view to or for sale in connection with any distribution
thereof and appropriate legends were affixed to the share certificates issued
in such transaction. All recipients had adequate access to information regarding
us.
ITEM 3. DEFAULTS ON SENIOR SECURITIES
Not applicable.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the second
quarter of 2000.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
27 Financial Data Schedule
(b) Reports on Form 8-K
July 11, 2000, related to the acquisition of Microtech
International.
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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: August 10, 2000
/s/ ANDREW WARNER
Andrew Warner
Vice President, Finance and Chief Financial
Officer (Principal Financial and Accounting
Officer)
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
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27 Financial Data Schedule
