[GRAPHIC OMITTED]
3,000,000 SHARES
COMMON STOCK
SmartDisk Corporation is offering 3,000,000 shares of its common stock.
This is our initial public offering and no public market currently exists for
our shares. The common stock has been approved for quotation on the Nasdaq
National Market under the symbol "SMDK."
---------------------
INVESTING IN OUR COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 4.
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PER SHARE TOTAL
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Public Offering Price ........................... $ 13.00 $39,000,000
Underwriting Discounts and Commissions .......... $ 0.91 $ 2,730,000
Proceeds to SmartDisk ........................... $ 12.09 $36,270,000
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THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS
HAVE NOT APPROVED OR DISAPPROVED THESE SECURITIES, OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
We have granted the underwriters a 30-day option to purchase up to an
additional 450,000 shares of common stock to cover over-allotments. BancBoston
Robertson Stephens Inc. expects to deliver the shares of common stock to
purchasers on October 12, 1999.
ROBERTSON STEPHENS
HAMBRECHT & QUIST
U.S. BANCORP PIPER JAFFRAY
The date of this prospectus is October 5, 1999.
<PAGE>
[INSIDE FRONT COVER]
Current FlashPath Product
FLASHPATH/trademark/
is the easiest way to
transfer data from
digital cameras SmartMedia/trademark/ flash mem-
[picture of a digital ory cards to PCs. Flash memory
camera with arrows pointing cards are miniature digital
from camera to flash data storage devices
memory card to FlashPath that are designed to
to computer to Internet, work with a range
with computer user at of audio and video
a desk viewing digital product applications.
image on computer screen] Primarily used today with
digital still cameras, FlashPath
offers users greater
portability, convenience,
and ease of use than any
other solution.
FlashPath Products Under Development
digital cameras digital music players SMARTDISK/TRADEMARK/
digital voice recorders is developing
digital phones digital video cameras FlashPath products
that are designed to
[picture of each of support leading flash
above-listed appliances] memory cards. We
expect to offer solutions
[picture of Memory Stick that keep pace with the
floppy disk constantly changing
adapter] landscape of digital
appliances and competing
[pictures of two computer users flash memory technologies.
viewing digital images
on computer screens, The above pictured flash memory
with "Internet" cards are manufactured by
superimposed between them] third parties.
<PAGE>
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE
HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT
CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO
BUY, SHARES OF COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE
PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF
THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS
PROSPECTUS OR OF ANY SALE OF THE COMMON STOCK. IN THIS PROSPECTUS, REFERENCES
TO "SMARTDISK," "WE," "OUR" AND "US" REFER TO SMARTDISK CORPORATION.
UNTIL OCTOBER 30, 1999, ALL DEALERS THAT BUY, SELL OR TRADE OUR COMMON
STOCK, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO
DELIVER A PROSPECTUS. THIS REQUIREMENT IS IN ADDITION TO THE DEALERS'
OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT
TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
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TABLE OF CONTENTS
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PAGE
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Prospectus Summary ................................................................... 1
Risk Factors ......................................................................... 4
Corporate History and Development .................................................... 16
Note Regarding Forward-Looking Statements ............................................ 17
Use of Proceeds ...................................................................... 17
Dividend Policy ...................................................................... 17
Capitalization ....................................................................... 18
Dilution ............................................................................. 19
Selected Financial Data .............................................................. 20
Management's Discussion and Analysis of Financial Condition and Results of Operations 21
Business ............................................................................. 29
Management ........................................................................... 41
Certain Transactions ................................................................. 50
Principal Stockholders ............................................................... 53
Description of Capital Stock ......................................................... 55
Shares Eligible for Future Sale ...................................................... 58
Underwriting ......................................................................... 60
Legal Matters ........................................................................ 62
Experts .............................................................................. 62
Where You can Find Additional Information ............................................ 62
Index to Financial Statements ........................................................ F-1
</TABLE>
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We own or have rights to the product names, tradenames and trademarks that we
use in conjunction with the sale of our products. This prospectus also contains
product names, tradenames and trademarks of other companies.
ii
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PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS SELECTED INFORMATION CONTAINED ELSEWHERE IN THIS
PROSPECTUS. YOU SHOULD READ THIS ENTIRE PROSPECTUS CAREFULLY.
OUR BUSINESS
SmartDisk designs and develops products that enable consumers to easily
share digital data among advanced consumer electronic products, PCs and the
Internet. Consumers are increasingly relying on the transfer of digital
information between electronic devices as an important part of their daily
lifestyles. We believe that our products provide an easy-to-use, cost-effective
and versatile solution for the exchange of digital data. Our patented products,
FlashPath and Smarty, allow consumers to use the familiar 3.5 inch floppy
drive--found on most PCs worldwide--to simplify the exchange of images, music,
voice and other digital data.
We have derived substantially all of our revenues to date from the sale of
our FlashPath product. FlashPath is a solid state electronic device in the
shape of a 3.5 inch floppy diskette. Our current FlashPath product is used
primarily to transfer images to PCs from consumer digital cameras using the
Toshiba SmartMedia flash memory card, which is currently the only flash memory
card commercially supported by our product. Flash memory cards are miniature
digital data storage devices that are designed to work with a range of audio
and video product applications. In digital cameras they serve as the camera's
film. Once pictures have been taken, the flash memory card is removed from the
camera and placed into FlashPath. FlashPath is then inserted into the PC's
floppy disk drive and the images are easily and conveniently transferred to the
PC, without the need to use connecting cables or PC peripheral ports. After
transferring the images to a PC, the consumer is able to edit and transmit the
pictures through the Internet using readily available software. SmartMedia
cards are used in cameras made by a number of leading camera manufacturers,
including Agfa, FujiFilm, Olympus, Polaroid, Ricoh, Sanyo, Sharp and Toshiba.
During the 12-month period ended June 30, 1999, we sold over 700,000
FlashPaths. At June 30, 1999, our accumulated deficit was $24.9 million.
We are currently developing, with Sony and SanDisk, additional FlashPath
products to support their flash memory cards--the Memory Stick and the
MultiMediaCard. These flash memory cards are expected to have applications in
"smart" cellular phones, digital cameras and camcorders, digital audio players
and video game devices. FlashPath is also capable of transferring digital music
downloaded from the Internet to the Diamond Rio MP3 audio player.
Our strategic relationships take a variety of forms. Sony reimburses us
for a portion of our development expenses with respect to the Memory Stick and
pays us additional fees during the course of development. Under our SanDisk
arrangement, we fund most of the development costs and will receive revenues
derived from the sale of our FlashPath for the MultiMediaCard. We will pay
SanDisk a royalty based on the portion of those revenues derived from sales to
parties other than SanDisk. We recently completed a limited production run of
FlashPath for the Memory Stick, and we anticipate commencing volume production
in time for commercial introduction of the product in the fourth quarter of
1999. We also expect to commercially introduce FlashPath for the MultiMediaCard
in the first quarter of 2000. In addition to our product development efforts
with Sony and SanDisk, as more fully discussed in "Business--Marketing,
Customers and Strategic Relationships," we also have strategic relationships
with a number of key electronics industry players, including Hitachi, NEC and
Toshiba. They actively participate in the development of our products, provide
us with access to leading-edge manufacturing capabilities, and market and
distribute our products globally. We currently outsource our manufacturing and
plan to continue this strategy for the foreseeable future.
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Our objective is to establish our FlashPath products as the
industry-standard solution for the transfer of data between digital appliances
and PCs by strengthening our position as a technological and market leader. Key
elements of our business strategy include:
/bullet/ Capitalizing on our technology expertise and technology platform
to expand our product offerings;
/bullet/ Expanding our customer and strategic industry relationships to
take advantage of the significant marketing clout of our OEM
customers and the new product insights that result from our
cooperative development activities;
/bullet/ Supporting different flash memory card standards, such as those
from SanDisk, Sony and Toshiba, in order to address the data
transfer needs of purchasers of emerging digital appliances that
use different flash memory cards;
/bullet/ Promoting market awareness of our products and the FlashPath and
Smarty brand names; and
/bullet/ Continuing our focus on easy-to-use products that do not require
hardware installation, connecting cables or the use of PC
peripheral ports, which are normally used to connect modems,
printers and other peripherals to the PC.
We were incorporated in Delaware on March 5, 1997 as "Fintos, Inc." and
changed our name to "SmartDisk Corporation" on September 26, 1997. Our
predecessor, SmartDisk Security Corporation, was incorporated on May 18, 1993.
We commenced significant operations related to our current products in January
1998, and we received our first significant capital contributions in May 1998.
Our executive offices are located at 3506 Mercantile Avenue, Naples, Florida
34104, and our telephone number is (941) 436-2500.
THE OFFERING
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<S> <C>
Common stock offered by SmartDisk ......... 3,000,000 shares
Common stock to be outstanding
after this offering ..................... 15,523,511 shares
Use of proceeds ........................... We intend to use the estimated $35.0 million net
proceeds from this offering for working capital,
potential acquisitions of technology or businesses and
other general corporate purposes.
Nasdaq National Market symbol ............. SMDK
</TABLE>
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Except as otherwise indicated, information in this prospectus is based on
the following assumptions:
/bullet/ The number of shares of our common stock to be outstanding after
the offering is based on shares outstanding as of August 31, 1999.
/bullet/ All share information gives retroactive effect to a one-for-four
reverse split of our common stock effected in August 1999.
2
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SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
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SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------- ---------------------------
1996 1997 1998 1998 1999
------------ ----------- ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues ....................... $ 500 $ 893 $ 15,323 $ 3,972 $ 13,993
Cost of revenues ..................... 367 301 12,600 3,252 10,271
--------- -------- -------- -------- --------
Gross profit (loss) .................. 133 592 2,723 720 3,722
Operating expenses:
Research and development ............ 720 1,412 1,608 685 2,454
Sales and marketing ................. 6 12 2,547 731 1,443
General and administrative .......... 3,418 3,184 4,149 2,086 1,971
Impairment loss ..................... 7,807 -- -- -- --
--------- -------- -------- -------- --------
Total operating expenses ............. 11,951 4,608 8,304 3,502 5,868
--------- -------- -------- -------- --------
Operating loss ....................... (11,818) (4,016) (5,581) (2,782) (2,146)
Net loss before income taxes ......... (11,818) (4,009) (5,605) (2,767) (2,088)
Income tax expense (benefit) ......... (2,348) (45) (102) (38) 68
--------- -------- -------- -------- --------
Net loss ............................. $ (9,470) $ (3,964) $ (5,503) $ (2,729) $ (2,156)
========= ======== ======== ======== ========
Net loss per share(1) ................ $ (1.25) $ (0.51) $ (0.68) $ (0.35) $ (0.24)
Shares used in computing net loss
per share(2) ....................... 7,579 7,739 8,040 7,774 9,043
</TABLE>
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<CAPTION>
JUNE 30, 1999
-----------------------------
ACTUAL AS ADJUSTED(3)
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<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents ....................... $ 1,335 $36,315
Working capital ................................. 1,125 36,105
Total assets .................................... 15,439 50,419
Redeemable common stock(4) ...................... 9,992 --
Total stockholders' equity (deficit)(4) ......... (6,133) 38,839
</TABLE>
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(1) Basic and diluted net loss per share are the same for all periods
presented.
(2) Shares used in computing net loss per share reflect the retroactive
adjustment of outstanding shares related to the mergers of SmartDiskette
Limited and SmartDisk Security Corporation into SmartDisk.
(3) Adjusted to give effect to our sale of the 3,000,000 shares of common stock
at a public offering price of $13.00 per share (after deduction of the
estimated underwriting discount and offering expenses) and the receipt and
application of the net proceeds. See "Use of Proceeds."
(4) Redeemable common stock will convert to nonredeemable common stock upon
completion of the offering.
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RISK FACTORS
BEFORE YOU INVEST IN OUR COMMON STOCK, YOU SHOULD BE AWARE OF THE RISKS
DESCRIBED BELOW. YOU SHOULD CAREFULLY CONSIDER THESE RISK FACTORS, TOGETHER
WITH ALL OF THE OTHER INFORMATION INCLUDED IN THIS PROSPECTUS, BEFORE YOU
DECIDE WHETHER TO PURCHASE SHARES OF OUR COMMON STOCK.
WE HAVE INCURRED OPERATING LOSSES AND CANNOT GUARANTEE THAT WE WILL EVER BE
PROFITABLE
We have incurred operating losses on a quarterly basis since inception. We
had operating losses of $5.6 million and $2.1 million during 1998 and the first
six months of 1999, respectively. In addition, as of June 30, 1999, we had an
accumulated deficit of $24.9 million. In light of our loss history, we cannot
assure you when, if ever, SmartDisk will be able to achieve or sustain
profitability on an annual or quarterly basis in the future.
WE HAVE A LIMITED OPERATING HISTORY ON WHICH TO BASE AN INVESTMENT DECISION
We were incorporated in March 1997, commenced operations in January 1998,
and our predecessor corporation only conducted limited operations. Further,
commercial sales of our primary product, FlashPath, only commenced in mid-1998.
As a result of our limited operating history, we have limited financial data
that can be used in evaluating our business and prospects and in projecting
future operating results.
OUR MANAGEMENT TEAM HAS ONLY RECENTLY BEEN ASSEMBLED AND MAY NOT BE ABLE TO
WORK TOGETHER AS A COHESIVE UNIT
Our Chief Financial Officer, Senior Vice President, Research and
Development, Vice President, Asian Operations, Vice President, Corporate
Development and Legal Affairs, and Vice President, Audio/Video Products all
joined SmartDisk during the last year. There is the possibility that our
management team may not be able to work together as a cohesive unit.
WE WILL NOT BE ABLE TO SELL SUFFICIENT QUANTITIES OF OUR PRODUCTS TO SUSTAIN A
VIABLE BUSINESS IF THE MARKET FOR FLASH MEMORY PRODUCTS DOES NOT DEVELOP OR IF
A COMPETING TECHNOLOGY DISPLACES FLASH MEMORY PRODUCTS
Our current and planned FlashPath products are designed to provide
connectivity between personal computers and digital appliances that use flash
memory cards. The flash memory market is in the early stage of development and
is still evolving. Our current dependence on sales of FlashPath and lack of
product diversification exposes us to a substantial risk of loss in the event
that the flash memory market does not develop or if a competing technology
replaces flash memory cards. If a competing memory storage device replaces or
takes significant market share from the flash memory cards which our products
support, we will not be able to sell our products in quantities sufficient to
grow our business.
WE MAY NOT BE ABLE TO SELL SUFFICIENT QUANTITIES OF OUR PRODUCTS TO SUSTAIN A
VIABLE BUSINESS IF A SINGLE STANDARD FOR FLASH MEMORY CARDS EMERGES
We believe that demand for our flash memory connectivity products is
driven, to a large extent, by the absence of a single standard for flash memory
cards. There are currently four major flash memory cards, none of which has
emerged as the industry standard. Should one of these cards or a new technology
emerge as an industry standard, flash memory card readers could be built in to
PCs, eliminating the need for our current flash memory connectivity products.
A REDUCTION IN THE USE OF THE 3.5 INCH FLOPPY DISK DRIVE BY CONSUMERS WOULD
LEAD TO A REDUCTION IN DEMAND FOR OUR PRODUCTS
Our current products only work in conjunction with the standard 3.5 inch
floppy disk drive. While the 3.5 inch floppy disk drive is today found in most
PCs, a number of newer PC models, such as the
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Apple iMac and the Apple G3 desktop, do not have this device and new industry
standards may emerge that render the 3.5 inch floppy disk drive obsolete.
Advances in input devices such as CD-ROM and removable data storage disk
drives, such as Zip drives, may reduce or eliminate the need for the 3.5 floppy
diskette, which will lead to a corresponding reduction in demand for our
products. We would then have to develop new products that use a different
interface between personal computers and digital appliances. We may not be able
to redesign our products to fit the new interface and demonstrate technological
feasibility of those products on a timely basis, if at all, or in a cost
effective manner.
SINCE OUR PRODUCTS ONLY WORK IN CONJUNCTION WITH THE 3.5 INCH FLOPPY DISK
DRIVE, ADVANCES IN FLASH MEMORY CARDS MAY MAKE OUR PRODUCTS LESS COMPETITIVE
BECAUSE OF THE INCREASED TIME NEEDED TO TRANSFER DATA USING THE 3.5 INCH FLOPPY
DISK DRIVE
Consumer acceptance of our products will depend upon their ability to
quickly transfer information from flash memory cards to PCs. However, the time
needed to transfer information using a 3.5 inch disk drive increases as more
data is transferred. As more memory is condensed on to flash memory cards, the
time necessary to transfer all of the data from a single card will increase. As
technological advances make it possible and feasible to produce higher density
cards, our ability to create products which quickly transfer all of the stored
information on a single card will be constrained by the inherent limitations of
the 3.5 inch disk drive. In that case, our products would be less attractive to
consumers and our sales would decline.
MOST OF OUR REVENUES ARE DERIVED FROM ONLY ONE PRODUCT AND OUR BUSINESS WILL BE
SERIOUSLY HARMED IF DEMAND FOR THAT PRODUCT DECLINES
To date, substantially all of our revenue has been derived from the sale
of our FlashPath product that stores data on and retrieves data from only the
SmartMedia flash memory card. While our long-term strategy is to derive revenue
from multiple products, we anticipate that the sale of FlashPath for SmartMedia
products will continue to represent the most substantial portion of our
revenues through at least 2000. A decline in the price of or demand for
FlashPath products as a result of competition, technological change, the
introduction of new products by us or others, a failure to adequately manage
product transitions, or for other reasons, would seriously harm our business.
For the year ended December 31, 1998 and the six months ended June 30, 1999, we
derived approximately 89.7% and 95.2%, respectively, of our product revenues
from the sale of FlashPath.
WE MUST DEVELOP NEW PRODUCTS AND INTRODUCE THEM IN A TIMELY MANNER IN ORDER TO
REMAIN COMPETITIVE
We operate in an industry that is subject to evolving industry standards,
rapid technological changes, rapid changes in consumer demands and the rapid
introduction of new, higher performance products which shorten product life
cycles. To be competitive in this demanding market, we must both continue to
refine current products so that they remain competitive, and continually
design, develop and introduce, in a timely manner, new data transfer products
that meet the performance and price demands of OEMs and consumers. These
development activities will require the investment of substantial resources
before revenues are derived from product sales. Any significant delay in
releasing new products would adversely affect our reputation, provide a
competitor a first-to-market opportunity or allow a competitor to achieve
greater market share. The growth of our business will depend on the timely
introduction and sale of our FlashPath products for the Sony Memory Stick and
the SanDisk MultiMediaCard. We have not yet demonstrated that we will be able
to develop these products on a timely basis and in a cost-effective manner, or
at all with respect to the MultiMediaCard. Even if we are able to do so, we
cannot guarantee that they will achieve market acceptance. Product development
is inherently risky because it is difficult to foresee developments in
technology, coordinate our technical personnel and strategic relationships, and
identify and eliminate design flaws. If we are unable to develop and sell new
products, we will not be able to continue our
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strategy of maintaining media neutrality, and our target market will be
limited. Further, we may not be able to recoup research and development
expenditures if new products are not widely commercially accepted.
WE MAY NOT BE ABLE TO DEVELOP OR MAINTAIN THE STRATEGIC RELATIONSHIPS NECESSARY
TO PROVIDE US WITH THE INSIGHT WE NEED TO DEVELOP COMMERCIALLY VIABLE PRODUCTS
We may not be able to produce commercially viable products if we are
unable to anticipate market trends and the price, performance and functionality
requirements of flash memory manufacturers. We must continue to collaborate
closely with our customers, flash memory manufacturers and our contract
manufacturers to ensure that critical development projects proceed in a
coordinated manner. This collaboration is also important because our ability to
anticipate trends and plan our product development activities depends to a
significant degree upon our continued access to information derived from the
strategic relationships we currently have with flash memory card manufacturers
and consumer product OEMs. However, collaboration is more difficult because
many of these companies are located overseas. If any of our current
relationships deteriorates or is terminated, or if we are unable to enter into
future alliances that provide us with comparable insight into market trends, we
will be hindered in our ability to produce commercially viable products.
OUR OPERATING RESULTS HAVE FLUCTUATED SIGNIFICANTLY AND MAY FLUCTUATE
SIGNIFICANTLY IN THE FUTURE, WHICH COULD LEAD TO DECREASES IN OUR STOCK PRICE
Our operating results have fluctuated significantly in the past and we
expect that they will continue to fluctuate in the future. If our future
operating results materially fluctuate or are below the expectations of stock
market analysts, our stock price would likely decline. Future fluctuations may
result from a variety of factors including the following:
/bullet/ The timing and amount of orders we receive from our customers,
which may be tied to seasonal demand for the consumer products
manufactured and sold by these OEMs;
/bullet/ Cancellations or delays of customer product orders, or the loss of
a significant customer;
/bullet/ Reductions in consumer demand for our customers' products
generally or for our products in particular;
/bullet/ The timing and amount of research and development expenditures;
/bullet/ The availability of manufacturing capacity necessary to make our
products;
/bullet/ General business conditions in our markets, particularly Japan, as
well as global economic uncertainty;
/bullet/ Any new product introductions, or delays in product introductions,
by us or our competitors;
/bullet/ Increased costs charged by our suppliers or changes in the
delivery of products to us;
/bullet/ Increased competition or reductions in the average selling prices
that we are able to charge;
/bullet/ Fluctuations in the value of foreign currencies, particularly the
Japanese yen, against the U.S. dollar; and
/bullet/ Changes in our product mix as well as possible seasonal demand for
our products.
As a result of these and other factors, we believe that period-to-period
comparisons of our historical results of operations are not a good predictor of
our future performance.
WE MAY FAIL TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY AND, THEREFORE,
LOSE OUR COMPETITIVE ADVANTAGE
Our proprietary technology with respect to 3.5 inch floppy disk drive
interfaces is critical to our future growth. We rely in part on patent, trade
secret, trademark and copyright law to protect our
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intellectual property. However, the patents issued to us may not be adequate to
protect our proprietary rights, to deter misappropriation or to prevent an
unauthorized third party from copying our technology, designing around the
patents we own or otherwise obtaining and using our products, designs or other
information. We have, in fact, filed a complaint against one of our former
patent attorneys for improperly copying one of our patent applications and
filing a patent application without our consent naming himself as a
co-inventor. This matter recently was settled with no materially adverse
consequences to SmartDisk. In addition, we may not receive trademark protection
for our "SmartDisk" name. We have filed for trademark registration of the name
"SmartDisk," but this has not yet been granted. We are aware of a trademark
application for the name "SmartDisk" that was filed by another company. Our
application could be denied and we could be prohibited from using the
"SmartDisk" name. In that event, we would be required to incur costs to
establish new name recognition.
We also claim copyright protection for some proprietary software and
documentation. We attempt to protect our trade secrets and other proprietary
information through agreements with our customers, employees and consultants,
and through other security measures. However, despite our efforts to protect
our intellectual property, unauthorized parties may attempt to copy aspects of
our products or obtain and use information and software that we regard as
proprietary. Those parties may have substantially greater financial resources
than us, and we may not have the resources available to challenge their use of
our proprietary technology. If we fail to adequately protect our intellectual
property, it will be easier for our competitors to sell competing products.
WE MAY FACE COMPETITION FROM INTEL IF IT DECIDES TO UTILIZE ITS COMPETING
PATENT
Intel Corporation was issued a patent in 1997 disclosing and claiming
technology substantially similar to that disclosed in one of our key patents.
The Intel patent was filed four years after our effective filing date, and we
do not believe that the Intel patent can be validly applied to any of the
technology disclosed in our patent. However, given the substantial resources
available to Intel, our financial condition could suffer if we engage in a
dispute with Intel. Our business could also be harmed if Intel's patent is
determined to be valid and Intel or any licensee of Intel decides to sue our
customers or develop and commercialize products based on its patent.
INFRINGEMENT CLAIMS BY THIRD PARTIES COULD RESULT IN COSTLY LITIGATION AND
OTHERWISE ADVERSELY IMPACT OUR BUSINESS
From time to time we may receive communications from third parties
asserting that our products infringe, or may infringe, the proprietary rights
of these third parties. These claims of infringement may result in protracted
and costly litigation which could require us to pay substantial damages or have
sales of our products stopped by an injunction. Infringement claims could also
cause product shipment delays, require us to redesign our products or require
us to enter into royalty or licensing agreements, any of which could harm our
business. For example, we received a letter from SanDisk stating that SanDisk
held two patents which might apply to our products. Although we subsequently
obtained a non-exclusive worldwide license for all of SanDisk's intellectual
property rights in connection with multimedia floppy disk interfaces for a
10-year period, if the license terminates or expires, we could face a potential
conflict with SanDisk regarding the scope of those patents. In another
instance, we received communications alleging that our FlashPath products
infringed a third party's patent rights. We also received correspondence
alleging that our SafeBoot product violated another third party's intellectual
property rights. We reviewed the patents and concluded that our products do not
infringe upon either of the third parties' patent rights. While none of these
claims has resulted in litigation, future claims may. In addition, we license a
portion of the intellectual property included in our products from third
parties, which may increase our exposure to infringement actions because we
rely upon those third parties for information about the origin and ownership of
the licensed intellectual property. We may also lose our license rights with
respect to the intellectual property for which infringement is claimed.
Further, if our customers are required to obtain a license on other than
commercially reasonable terms, our business could be jeopardized.
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WE MAY HAVE PARTICULAR DIFFICULTY PROTECTING OUR INTELLECTUAL PROPERTY RIGHTS
OVERSEAS
The laws of some foreign countries do not protect proprietary rights to as
great an extent as do the laws of the United States, and many U.S. companies
have encountered substantial infringement problems in some foreign countries.
Because most of our products are sold and most of our business is conducted
overseas, our exposure to intellectual property risks may be higher.
BECAUSE MOST OF OUR SALES ARE TO A RELATIVELY SMALL NUMBER OF CUSTOMERS,
PRIMARILY ORIGINAL EQUIPMENT MANUFACTURERS, THE LOSS OF ANY OF OUR KEY
CUSTOMERS WOULD SERIOUSLY HARM OUR BUSINESS
Our business will be seriously harmed if we lose any of our significant
customers, particularly Olympus or FujiFilm, or suffer a substantial reduction
in or cancellation of orders from these customers. Our current strategy is
principally based on sales to OEMs, which results and will continue to result
in sales to only a limited number of customers. Our products are sold as
stand-alone products by OEMs and, to a lesser extent, are bundled together and
sold with systems manufactured by third party OEMs. We currently sell to seven
OEMs, sales to which collectively accounted for approximately 81.0% and 76.0%
of our revenues for 1998 and the first six months of 1999, respectively. More
specifically, Olympus and FujiFilm accounted for approximately 32.0% and 38.0%
of our revenues in fiscal 1998 and our top five customers collectively
accounted for approximately 92.8% of our revenues during that period. In the
six months ended June 30, 1999, Olympus and FujiFilm accounted for
approximately 36.0% and 29.0% of our revenues and our top five customers
collectively accounted for approximately 86.0% of our revenues during that
period. Furthermore, we expect to continue to depend on sales of our products
to relatively few customers, which will continue to account for a significant
portion of our net revenues, for the foreseeable future.
OUR CUSTOMERS COULD STOP PURCHASING OUR PRODUCTS AT ANY TIME BECAUSE WE DO NOT
HAVE LONG-TERM PURCHASE CONTRACTS WITH THEM
No OEM or other customer is contractually obligated to purchase products
from us. As a result, our customers are free to cancel their orders or stop
ordering our products at any time. In addition, even if we are able to
demonstrate that our products are superior, OEMs may still choose not to bundle
our products with theirs or market and distribute our products on a stand-alone
basis. OEMs may also change their business strategies and manufacturing
practices, which could cause them to purchase fewer of our products, find other
sources for products we currently manufacture or manufacture these products
internally.
OUR ABILITY TO SELL OUR PRODUCTS WILL BE LIMITED IF THE OEMS' PRODUCTS DO NOT
ACHIEVE MARKET ACCEPTANCE OR IF THE OEMS DO NOT ADEQUATELY PROMOTE OUR PRODUCTS
We depend upon our OEM customers to market our products and we do not have
significant experience and resources devoted to independent marketing efforts.
Failure of the OEMs' products to achieve market acceptance, the failure of the
OEMs to bundle our products with theirs, or any other event causing a decline
in our sales to the OEMs could seriously harm our business. Even if consumers
buy OEMs' products, their ultimate decision to buy our products depends on OEM
packaging, distribution and sales efforts, which may not be sufficient to
maintain or increase sales of our products. If we cannot achieve or maintain a
sufficient consumer acceptance rate of our products concurrent with their
purchases of OEM products, our future sales to OEM customers will be adversely
affected.
A NEW OR COMPETING DATA TRANSFER SOLUTION THAT ACHIEVES SIGNIFICANT MARKET
SHARE OR RECEIVES SIGNIFICANT SUPPORT FROM FLASH CARD MANUFACTURERS WOULD
JEOPARDIZE OUR BUSINESS
Our products currently compete with a number of cable and non-cable
interfaces between personal computers and digital appliances, including ports,
USBs, PCMCIA slots and infrared interfaces, all of which are PC peripheral
interfaces. It is possible that one of these competing data
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transfer solutions, or another existing or new technology, could achieve a
significant market presence or become supported by a number of significant
flash memory card or digital appliance manufacturers. Regardless of the
relative benefits of our products, if a competing product gains significant
market share or significant support of flash card manufacturers, this product
would likely emerge as the industry standard and thereby achieve a dominant
market position that would jeopardize our survival.
SINCE WE SELL OUR PRODUCTS TO A LIMITED NUMBER OF LARGE CUSTOMERS, WE EXPECT
THOSE CUSTOMERS TO PRESSURE US TO MAKE PRICE CONCESSIONS, WHICH WOULD REDUCE
OUR FUTURE GROSS MARGINS
Our reliance on sales to a limited number of large customers exposes us to
pressure for price concessions. Because of this reliance and because of our
dependence on OEMs as our primary distribution channel, we expect that our OEM
customers may seek price concessions from us, which would reduce our average
selling prices and our gross margins. Since we do not manufacture our own
products, we may be unable to reduce our manufacturing costs in response to
declining average per unit selling prices.
WE EXPECT TO CONTINUE OUTSOURCING KEY OPERATIONAL FUNCTIONS AND OUR ABILITY TO
DO SO WILL BE IMPAIRED IF WE ARE UNABLE TO MAINTAIN OUR STRATEGIC RELATIONSHIPS
We have formed strategic relationships with a number of significant
industry participants, including FujiFilm, Hitachi, Olympus, Rohm, SanDisk,
Sony, Toshiba, Visa and Yamaichi. We depend upon these corporations to provide
technical assistance and perform key manufacturing, marketing, distribution and
other functions. For example, Yamaichi is currently one of two manufacturers of
our FlashPath products, Toshiba provides technological assistance in the
development of our products, and Olympus and FujiFilm market our products. We
expect that these and similar types of relationships will be critical to our
growth because our business model calls for the continued outsourcing of many
key operational functions and we do not currently have the resources to perform
these functions ourselves.
WE MUST OVERCOME GEOGRAPHIC AND CULTURAL DIFFERENCES IN ORDER TO MAINTAIN OUR
STRATEGIC RELATIONSHIPS
There are inherent difficulties in developing and maintaining
relationships with foreign entities. Language and cultural differences often
impair relationships, and geographical distance, at times, is also an
impediment. We must overcome these difficulties. If any of our current
relationships is impaired, or if we are unable to develop additional strategic
relationships in the future, our product development costs would significantly
increase and our business would be materially and adversely affected.
OUR SALES AND EXPENSES ARE GEOGRAPHICALLY CONCENTRATED IN JAPAN, AND,
THEREFORE, WE COULD SUFFER FROM EXCHANGE RATE FLUCTUATIONS AND ECONOMIC AND
POLITICAL DIFFICULTIES
Approximately 84.0% of our revenues for 1998 were attributable to sales to
Japanese customers, and we expect that sales to Japanese customers will
continue to account for a significant portion of our total revenues for the
foreseeable future. All of our Japanese sales, as well as the related expenses,
are denominated in yen. Fluctuations in exchange rates between the yen and the
U.S. dollar, particularly with respect to Japanese transactions denominated in
a currency other than the yen, could adversely impact our financial results.
Some transactions and accounts of our Japanese subsidiary are U.S. dollar
denominated. Since the Japanese subsidiary's accounting records are kept in
yen, those U.S. dollar denominated transactions are accounted for in yen at the
time of the transaction. U.S. dollar denominated accounts are remeasured at the
end of the accounting period. This remeasurement results in adjustments to
income. In addition, the balance sheet accounts of our Japanese subsidiary are
translated to the U.S. dollar for financial reporting purposes and resulting
adjustments are made to stockholders equity. The value of the yen may
deteriorate against the dollar, which would impair the value of stockholders'
investment in us. Deterioration of the yen against the dollar has occurred in
recent years, resulting in a foreign currency loss of approximately $48,000 and
a foreign currency
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translation loss adjustment to equity of approximately $290,000 for 1998.
Further, we do not currently hedge against foreign currency exposure. 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 are also subject to risks associated with a significant amount of sales
being made to one geographical area. An economic downturn in Asia generally,
and Japan in particular, could lead to a reduced demand for our products. In
recent years, Japan has been subject to political and economic instability and,
while that instability has not yet adversely impacted us, if it continues,
sales of our products in Japan may be adversely affected.
Given our dependence on sales to Japanese customers, we must develop and
maintain alliances in Japan to help with the promotion and distribution of our
products. We may not be able to develop or maintain these alliances.
OUR FOREIGN OEM CUSTOMERS MAY CHOOSE TO WORK WITH A LOCAL COMPETITOR, WHICH
WOULD ADVERSELY IMPACT OUR SALES
Our OEM customers, most of which are based in Japan and to whom most of
our sales are made, may choose to work with, and purchase products from, a
local competitor if one were able to provide a substitute product. This may
occur because of geographic distance, time differences, or for other reasons.
In that event, we may not be able to find other OEM customers and our sales
could decline.
WE DEPEND ON A LIMITED NUMBER OF CONTRACT AND OFFSHORE MANUFACTURERS, AND IT
MAY BE DIFFICULT TO FIND REPLACEMENT MANUFACTURERS IF OUR EXISTING
RELATIONSHIPS ARE IMPAIRED
We contract with offshore manufacturers to produce our products and our
dependence on a limited number of contract manufacturers exposes us to a
variety of risks, including shortages of manufacturing capacity, reduced
control over delivery schedules, quality assurance, production yield and costs.
Yamaichi and Mitsumi are the sole manufacturers of our FlashPath products. We
do not have contracts with either Yamaichi or Mitsumi. If Yamaichi or Mitsumi
terminates production or cannot meet our production requirements, we may have
to rely on other contract manufacturing sources or identify and qualify new
contract manufacturers. The lead time required to qualify a new manufacturer
could range from approximately three to six months. 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. Any significant delay in our ability
to obtain adequate quantities of our products from our current or alternative
contract manufacturers would cause our sales to decline.
TOSHIBA INTRODUCED US TO ONE OF OUR MANUFACTURERS AND WE MAY NOT BE ABLE TO
RETAIN THE SERVICES OF THE MANUFACTURER IF OUR RELATIONSHIP WITH TOSHIBA IS
IMPAIRED
Yamaichi, one of the manufacturers of our FlashPath products, was
introduced to us by Toshiba, which is one of our major stockholders. If our
relationship with Toshiba is impaired, we may not be able to retain the
services of Yamaichi in manufacturing our products.
OUR DEPENDENCE ON FOREIGN MANUFACTURING AND INTERNATIONAL SALES EXPOSES US TO
DIFFICULTIES OFTEN NOT ENCOUNTERED BY EXCLUSIVELY DOMESTIC COMPANIES
Our products are manufactured overseas and a substantial portion of our
revenues are derived from overseas sales. Approximately 90.0% and 87.0% of our
revenues in 1998 and the first six months of 1999, respectively, were derived
from customers located outside the United States, primarily in Japan. Our
dependence on foreign manufacturers and international sales poses a number of
risks, including:
/bullet/ difficulties in monitoring production;
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/bullet/ transportation delays and interruptions;
/bullet/ unexpected changes in regulatory requirements;
/bullet/ currency exchange risks;
/bullet/ tariffs and other trade barriers, including import and export
restrictions;
/bullet/ difficulties in staffing and managing disparate branch operations;
/bullet/ political or economic instability;
/bullet/ compliance with foreign laws;
/bullet/ difficulties in protecting intellectual property rights in foreign
countries;
/bullet/ exchange controls; and
/bullet/ potential adverse tax consequences, including with respect to
repatriation of earnings.
We intend to continue manufacturing our products overseas and we
anticipate that international sales will continue to account for a significant
portion of our revenues. Therefore, we expect to be subject to the risks
outlined above for the foreseeable future.
WE HAVE A LIMITED NUMBER OF SUPPLIERS OF KEY COMPONENTS AND OUR ABILITY TO
OBTAIN FINISHED PRODUCTS WILL BE IMPAIRED IF WE ARE UNABLE TO OBTAIN SUFFICIENT
QUANTITIES OF COMPONENTS
Rohm is our sole provider of application specific integrated circuits, or
ASICs, for our FlashPath products and we purchase ASICs for Smarty from Rohm
and Atmel. In our products, the specific function of these integrated circuits
is the conversion of digital and analog data. Our dependence on a limited
number of suppliers and our lack of long-term supply contracts exposes us to
several risks, including a potential inability to obtain an adequate supply of
components, price increases, late deliveries and poor component quality.
Disruption or termination of the supply of components could delay shipments of
our products. The lead time required for orders of some of our components is as
much as six months. In addition, the lead time required to qualify new
suppliers for our components is as much as 12 months. If we are unable to
accurately predict our component needs, or if our component supply is
disrupted, we may miss market opportunities by not being able to meet the
demand for our products. This may damage our relationships with current and
prospective customers.
OUR CURRENT AND POTENTIAL COMPETITORS HAVE SIGNIFICANTLY GREATER RESOURCES THAN
WE DO, AND INCREASED COMPETITION COULD HARM SALES OF OUR PRODUCTS
Increased competition is likely to result in price reductions, reduced
operating margins and loss of market share. Many of our current and potential
competitors have significantly greater financial, technical, marketing,
purchasing and other resources than we do. As a result, our competitors may be
able to respond more quickly to new or emerging technologies or standards and
to changes in customer requirements. Our competitors may also be able to devote
greater resources to the development, promotion and sale of products, and may
be able to deliver competitive products at a lower end-user price. Current and
potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products to address the needs of our prospective customers. Therefore, it
is possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share.
OUR BUSINESS MAY SUFFER IF WE ARE UNABLE TO MANAGE OUR GROWTH
Failure to effectively manage our growth could impair our ability to
execute our business strategy. Our business has grown substantially in recent
periods, with revenues increasing from approximately $4.0 million in the first
six months of 1998 to approximately $14.0 million in the first six months of
1999. The growth of our business has placed a strain on our management,
operations and financial
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systems. In addition, the number of employees has increased from 16 at January
1, 1998 to 49 as of August 31, 1999. We expect to continue to increase the
number of employees as our business grows, and may expand operations to
locations other than those in which we currently operate.
Continued growth is likely to place a greater burden on our operating and
financial systems as well as our senior management and other personnel.
Existing and 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. Management of our operations in diverse locations may also
complicate the task of managing our growth.
OUR GROWTH PROSPECTS WILL BE REDUCED IF THE SMART CARD MARKET DOES NOT DEVELOP
SmartDisk's future growth and operating results will depend, in part, on
whether our Smarty family of smart card readers achieves significant sales. A
smart card reader retrieves information from a card that uses a microprocessor
or memory chip for security and data storage purposes. The current primary use
for Smarty is as a smart card token-based security application designed to
provide protection from unauthorized access to digital information. However,
the market for network and electronic commerce security applications is still
emerging and the smart card may not become the industry standard for these
applications. Similarly, the market for other smart card applications may not
develop, or may develop more slowly than we expect. If the market for the
Smarty family of products fails to develop or develops more slowly than
expected, or if any of the standards supported by us do not achieve or sustain
market acceptance, our growth prospects would be reduced.
WE HAVE INDEMNIFICATION OBLIGATIONS RELATED TO OUR INTELLECTUAL PROPERTY, WHICH
MAY REQUIRE US TO PAY DAMAGES
Our arrangements with SanDisk, Sony and Toshiba require us to indemnify
them for any damages they may suffer if a third party claims that we are
violating their intellectual property rights. While, to date, we have not
received indemnification claims, there may be future claims. Any
indemnification claim may require us to pay substantial damages, which could
negatively impact our financial condition.
OUR PRODUCTS MAY BE RETURNED TO US BY OUR CUSTOMERS IF PROJECTED CONSUMER
DEMAND DOES NOT MATERIALIZE, WHICH WOULD LEAD TO A REDUCTION IN OUR REVENUES
Lack of consumer demand for our products may result in efforts by OEMs to
return products to us. While we are not contractually obligated to accept
returned products, we may determine that it is in our best interest to accept
returns in order to maintain good relations with our customers. Product returns
would reduce our revenues. While we have experienced very limited product
returns to date, returns may increase in the future.
WE COULD BE HELD LIABLE FOR PRODUCT DEFECTS, WHICH COULD REQUIRE US TO PAY
SUBSTANTIAL DAMAGES AND HARM OUR REPUTATION WITH OUR CUSTOMERS
Complex products such as ours frequently contain errors, defects and bugs
when first introduced or as new versions are released. Delivery of products
with production defects or reliability, quality or compatibility problems could
hinder market acceptance of our products, which could damage our reputation and
harm our ability to attract and retain customers. Errors, defects or bugs could
also cause interruption, delays or a cessation of sales to our customers, and
could subject us to warranty claims from our customers. We would have to expend
significant capital and resources to remedy these problems. Errors, defects or
bugs could be discovered in our new products after we begin commercial
production of them, despite testing by us and our suppliers and customers. This
could result in additional development costs, loss of, or delays in, market
acceptance, diversion of technical and other resources from our other
development efforts, claims by our customers or others against us or the loss
of credibility with our current and prospective customers.
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OUR EXECUTIVE OFFICERS AND KEY PERSONNEL ARE CRITICAL TO OUR BUSINESS, AND
THESE OFFICERS AND PERSONNEL MAY NOT REMAIN WITH US IN THE FUTURE
We depend upon the continuing contributions of our key management, sales
and product development personnel. The loss of any of those personnel could
seriously harm us. Although some of our officers are subject to employment
agreements, we cannot be sure that we will retain their services. In addition,
we have not obtained key-person life insurance on any of our executive officers
or key employees.
OUR LOCATION IN NAPLES, FLORIDA MAKES IT MORE DIFFICULT TO HIRE QUALIFIED
TECHNICAL PERSONNEL
Our technology is specialized and complex, requiring us to recruit and
train qualified technical personnel. However, there are many employers
competing to hire qualified technical personnel and we may have difficulty
attracting and retaining qualified technical personnel. Our recruiting efforts
are further hindered by the lack of a readily available pool of candidates in
Naples, Florida, where we are headquartered. The inability to attract and
retain qualified personnel could make it more difficult to develop our products
and execute our business strategy.
WE ARE CONTROLLED BY A PRINCIPAL STOCKHOLDER WHO MAY PREVENT OR DELAY A CHANGE
OF CONTROL AND WHOSE INTERESTS MAY BE DIFFERENT FROM THOSE OF OUR OTHER
STOCKHOLDERS
Addison Fischer, the Chairman of our board of directors, will beneficially
own approximately 51.3% of SmartDisk after the offering. Accordingly, Mr.
Fischer will be able to control SmartDisk, subject to his fiduciary duty as a
director under Delaware law. The interests of Mr. Fischer may not always
coincide with our interests or the interests of other stockholders, and he
could cause us to enter into transactions or agreements which we would not
otherwise consider absent his influence.
The purchasers of common stock in this offering will not have sufficient
voting power to elect any members of our board of directors. As a result, Mr.
Fischer will be able to exercise control over all matters requiring stockholder
approval, including the election of directors and approval of significant
corporate transactions, which could have the effect of delaying or preventing a
change of control of SmartDisk.
OUR BUSINESS COULD BE AFFECTED BY YEAR 2000 ISSUES
The "Year 2000 Issue" refers generally to the problems that some software
may have in determining the correct century of the year. Many existing
electronic systems, including computer systems, use only the last two digits to
refer to a year. Therefore, these systems may recognize a date using "00" as
1900 rather than the year 2000. If not corrected, these electronic systems
could fail or create erroneous results when addressing dates on and after
January 1, 2000. The Year 2000 Issue could adversely impact our business. For a
more complete discussion, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Year 2000 Issues."
WE HAVE ANTITAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN ACQUISITION OF OUR
COMPANY
Some provisions of our certificate of incorporation and bylaws and the
provisions of Delaware law could have the effect of delaying, deferring or
preventing an acquisition of SmartDisk. For example, we have a staggered board
of directors, the members of which may only be removed for cause, authorized
but unissued shares of preferred stock which could be used to fend off a
takeover attempt, our stockholders may not take actions by written consent and
our stockholders are limited in their ability to make proposals at stockholder
meetings.
WE MAY NEED TO RAISE ADDITIONAL CAPITAL WHICH MIGHT NOT BE AVAILABLE OR WHICH,
IF AVAILABLE, MIGHT ONLY BE AVAILABLE ON TERMS ADVERSE TO PERSONS BUYING SHARES
IN THIS OFFERING
We expect the net proceeds from this offering, our current cash and cash
equivalents and cash from commercial borrowing availability under credit
facilities will meet our working capital and capital
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expenditure needs for at least one year. After that, we may need to raise
additional funds, and we cannot be certain that we will be able to obtain
additional financing on favorable terms, if at all. We may also require
additional capital for the acquisition of businesses, products and technologies
that are complementary to ours. Further, if we issue equity securities, the
ownership percentage of our stockholders would be reduced, and the new equity
securities may have rights, preferences or privileges senior to those of
existing holders of our common stock. If we cannot raise needed funds on
acceptable terms, we may not be able to develop or enhance our products, take
advantage of future opportunities or respond to competitive pressures or
unanticipated requirements, which could seriously harm our business, operating
results and financial condition.
OUR STOCK MAY BE THINLY TRADED OR VOLATILE, WHICH MIGHT MAKE IT HARD FOR
INVESTORS TO SELL THEIR SHARES AT A PREDICTABLE PRICE, OR AT ALL
Prior to this offering, you could not buy or sell our common stock on a
public market. An active public market for our common stock may not develop or
be sustained after this offering. We negotiated and determined the initial
public offering price with the representatives of the underwriters based upon
several factors, and this price will likely vary from the market price after
this offering. The market price of our common stock will likely fluctuate
significantly in response to the following factors, some of which are beyond
our control:
/bullet/ Variations in our quarterly operating results;
/bullet/ Changes in financial estimates of our revenues and operating
results by securities analysts;
/bullet/ Announcements by us or our competitors of significant contracts,
acquisitions, strategic partnerships, joint ventures or capital
commitments;
/bullet/ Loss of or decrease in sales to a major customer or failure to
complete significant transactions;
/bullet/ Additions or departures of key personnel;
/bullet/ Future sales of our common stock, including sales which dilute
existing investors;
/bullet/ Stock market price and volume fluctuations attributable to
inconsistent trading volume levels of our stock;
/bullet/ General stock market conditions;
/bullet/ Commencement of or involvement in litigation; and
/bullet/ Announcements by us or our competitors of key innovations or
product introductions.
WE COULD BE SUBJECT TO CLASS ACTION LITIGATION DUE TO STOCK PRICE VOLATILITY,
WHICH, IF IT OCCURS, WILL DISTRACT MANAGEMENT, RESULT IN SUBSTANTIAL COSTS AND
HARM OUR BUSINESS
In the past, securities class action litigation has often been brought
against companies following periods of volatility in the market price of their
securities. We may be the target of similar litigation in the future.
Securities litigation could result in substantial costs and divert management's
attention and resources, which could cause serious harm to our business.
FUTURE SALES OF OUR COMMON STOCK MAY DEPRESS OUR STOCK PRICE
After this offering, we will have approximately 15.5 million shares of
common stock outstanding. Of these shares, the 3.0 million sold in this
offering will be freely tradable without restriction under the Securities Act
except for any shares held by "affiliates" of SmartDisk as that term is defined
in Rule 144 of the Securities Act. As of August 31, 1999, approximately 12.5
million shares of common stock held by existing stockholders were "restricted
shares" as that term is defined in Rule 144, and these shares will be available
for sale in the public market commencing 180 days after the date of this
prospectus, or earlier if the underwriters release their lock-up restrictions.
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As of August 31, 1999, there were options to purchase 1,039,750 shares of
our common stock outstanding. Should the holders of these options exercise
their options, there will be additional shares eligible for sale 180 days after
the date of this prospectus.
Three of our principal stockholders have the right to require us to file a
registration statement to enable them to sell their shares. These and one other
stockholder also have the right to require us to include their shares in
subsequently filed registration statements.
If our stockholders sell substantial amounts of the common stock,
including shares issued upon the exercise of outstanding options, in the public
market, the market price of our common stock could fall. For more detailed
information regarding future sales of our common stock, please see "Shares
Eligible for Future Sale" and "Underwriting."
OUR CURRENT STOCKHOLDERS WILL BENEFIT FROM THIS OFFERING, AND YOU WILL
EXPERIENCE IMMEDIATE DILUTION
The initial public offering price is substantially higher than the current
book value per share of our outstanding common stock. Stockholders existing as
of June 30, 1999 have paid an average of $2.36 per share for their common
stock, which is considerably less than the amount to be paid for the common
stock in this offering. As a result, investors purchasing common stock in this
offering will incur immediate and substantial dilution. In addition, we have
issued options to acquire common stock at prices significantly below the
initial public offering price. To the extent those outstanding options are
ultimately exercised, there will be further dilution to investors in this
offering.
WE HAVE BROAD DISCRETION TO USE THE OFFERING PROCEEDS AND HOW WE INVEST THESE
PROCEEDS MAY NOT YIELD A FAVORABLE RETURN
The principal purposes of this offering are to increase our equity
capital, to create a public market for our shares, to facilitate our future
access to public equity markets and to provide increased visibility and
credibility for us in a marketplace in which many of our current and potential
competitors are or are expected to be publicly held companies. As of the date
of this prospectus, we have no definite plans to use the net proceeds from the
offering other than for general corporate purposes, including possible
acquisitions, although none is as yet imminent, and plan to invest the net
proceeds in short-term, investment-grade, interest-bearing securities.
Accordingly, our management will retain broad discretion to allocate a
substantial portion of the net proceeds from this offering to uses that the
stockholders may not deem as desirable. Our use of the net proceeds may not
yield a significant return.
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CORPORATE HISTORY AND DEVELOPMENT
SmartDisk Security Corporation, or SDSC, our predecessor, was incorporated
in May 1993. At the time of incorporation, SDSC was 100% beneficially owned by
Addison Fischer, the Chairman of SmartDisk's board of directors and SmartDisk's
principal stockholder. Upon formation, SDSC entered into a manufacturing
license agreement with SmartDiskette Limited, or SDL, the indirect owner of
SmartDisk's key patents, which was also controlled by Mr. Fischer. Under this
agreement, SDL granted SDSC a license to manufacture, distribute and sell
diskettes or diskette connectors relating to the fields of data and computer
security, validation, and access control.
From 1993 to 1995, SDSC exploited the licensed technology on its own
behalf. However, in 1996 it entered into an operating agreement with Fischer
International Systems Corporation, a data security company also controlled by
Mr. Fischer, to provide operating services to enhance, manufacture and sell
products using this technology. Under this arrangement, SDSC developed
SafeBoot, a software product for computer and network security, as well as
SmartDisk's initial Smarty and FlashPath products.
On March 5, 1997 SmartDisk Corporation was incorporated. Its initial name
was "Fintos, Inc." which was changed to "SmartDisk Corporation" in September
1997.
In January 1998, SmartDisk entered into an operating agreement with SDSC
and Fischer International and commenced operations. Under this operating
agreement, SmartDisk and Fischer International agreed to provide operating
services to SDSC and to market and develop SafeBoot, Smarty and FlashPath on
behalf of SDSC.
In February 1998, Phoenix House Investments, L.L.C., an investment company
controlled by Mr. Fischer, Fischer International and Toshiba entered into a
joint venture agreement which detailed a plan of capital contribution,
corporate governance and business strategies for SmartDisk. Although SmartDisk
commenced operations in January 1998, it was under this strategic arrangement
that SmartDisk received its first significant capital contributions and became
the successor-in-interest to SDSC.
In May 1998, Mr. Fischer contributed his shares of SDSC to Phoenix House
in exchange for limited liability company units. Phoenix House was, for a short
time, the sole owner of SDSC.
Before the significant capital contributions discussed below, all
outstanding shares of SmartDisk were owned by employees of, or consultants to,
SmartDisk, as a result of the exercise of stock options. None of SmartDisk's
current directors, executive officers or significant shareholders owned any
shares before the purchases described below.
The joint venture arrangement became effective in May 1998, with the
following results:
/bullet/ Toshiba purchased 2,487,500 shares of SmartDisk common stock,
representing approximately 23.3% of SmartDisk's common stock
immediately after the purchase, in exchange for approximately $10.0
million, consisting of a cash payment of approximately $5.0 million
and the cancellation of a $5.0 million note which evidenced a prior
loan made by Toshiba to SmartDisk.
/bullet/ Phoenix House purchased 7,350,000 shares of SmartDisk common
stock, representing approximately 68.8% of SmartDisk's common stock
immediately after the purchase, in exchange for all of the
outstanding shares of SDSC.
/bullet/ Fischer International purchased 150,000 shares of SmartDisk common
stock, representing approximately 1.4% of SmartDisk's common stock
immediately after the purchase, in exchange for trademarks it owned
relating to SafeBoot, FlashPath and Smarty.
/bullet/ SDSC became a wholly owned subsidiary of SmartDisk.
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/bullet/ Fischer International, Toshiba, and Phoenix House became
SmartDisk's major shareholders.
In June 1998, SDSC was merged into SmartDisk and the separate corporate
existence of SDSC ended.
In May 1999, Phoenix House and the other shareholders of SDL exchanged all
of their SDL shares for 515,500 shares of SmartDisk common stock. As a result
of the exchange, SDL became a wholly owned subsidiary of SmartDisk.
NOTE REGARDING FORWARD-LOOKING STATEMENTS
All statements, trend analyses and other information contained in this
prospectus regarding markets for our products and trends in net revenues, gross
margin and anticipated expense levels, and any statement that contains the
words "anticipate," "believe," "plan," "estimate," "expect," "should," "intend"
and other similar expressions, constitute forward-looking statements. These
forward-looking statements are subject to business and economic risks,
including those risks identified in "Risk Factors" and elsewhere in this
prospectus and our actual results of operations may differ significantly from
those contained in the forward-looking statements because of those risks. The
cautionary statements made in this prospectus apply to all forward-looking
statements wherever they appear in this prospectus.
USE OF PROCEEDS
We estimate that our net proceeds from the sale of the 3,000,000 shares of
common stock that we are offering will be approximately $35.0 million at an
initial public offering price of $13.00 per share, after deducting estimated
offering expenses of approximately $1.3 million and underwriting discounts and
commissions payable by SmartDisk. We are conducting this offering primarily to
increase our working capital, increase our visibility in the marketplace,
create a public market for our common stock, and enable us to access public
equity markets in the future. We expect to use a portion of the net proceeds to
facilitate execution of our business plan, including for sales and marketing
activities, product development and support and capital expenditures. We
currently project that over the next 12 months we will spend a minimum of $6.1
million for research and development, including $2.0 million for our Atlanta
audio/video products development center, as well as $3.3 million for sales and
marketing and $3.0 million for capital expenditures. The capital expenditures
are expected to fund improvements in the technical infrastructure, purchases of
production equipment, including tools and dies for the products we are
developing, improvements in our operational and financial information systems,
and office space expansion. We also expect to use approximately $700,000 of the
net proceeds to pay the estimated tax liability related to the transfer of the
ownership of our principal patents from our German subsidiary to a new
subsidiary that we intend to establish in the Cayman Islands. The amount of net
proceeds that we actually spend for these purposes will depend significantly on
a number of factors, including our future revenues and our ability to generate
cash from operations. We have not yet determined the amount of net proceeds to
be used for any specific purpose. Therefore, management will have significant
flexibility in applying the net proceeds of this offering.
We may also use a portion of the net proceeds to acquire or invest in
complementary businesses, products or technologies or to obtain the right to
use complementary technologies. We have no agreements or commitments with
respect to any acquisition or investment, and are not involved in any
negotiations with respect to any transaction.
Pending use of the net proceeds for the above purposes, we intend to
invest the net proceeds of this offering in short-term, interest bearing,
investment grade securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock or
other securities and do not anticipate paying cash dividends in the foreseeable
future.
17
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of June 30, 1999:
/bullet/ On an actual basis; and
/bullet/ On an as adjusted basis to reflect the sale of the 3,000,000
shares of common stock offered by this prospectus at an initial
public offering price of $13.00 per share, assuming the conversion
of the redeemable common stock, which will occur if the public
offering is completed, and the application of the net proceeds we
will receive from the offering in the manner described in "Use of
Proceeds."
<TABLE>
<CAPTION>
JUNE 30, 1999
-----------------------------------
ACTUAL AS ADJUSTED
---------------- ----------------
<S> <C> <C>
Cash and cash equivalents .......................................... $ 1,335,145 $ 36,315,145
============= =============
Redeemable common stock: 2,487,500 shares issued and outstanding,
actual, and none issued and outstanding, as adjusted ............. $ 9,991,918 $ --
------------- -------------
Stockholders' (deficit) equity:
Common Stock, $0.001 par value; 60,000,000 shares authorized;
9,716,988 shares issued and 9,636,011 shares outstanding, actual;
and 15,204,488 shares issued and 15,123,511 shares outstanding,
as adjusted ..................................................... 9,717 15,204
Capital in excess of par value .................................... 18,716,040 63,682,471
Treasury stock .................................................... (58,304) (58,304)
Accumulated other comprehensive income ............................ 473,517 473,517
Notes receivable from officers/employees .......................... (417,334) (417,334)
Accumulated deficit ............................................... (24,856,659) (24,856,659)
------------- -------------
Total stockholders' equity (deficit) ............................. (6,133,023) 38,838,895
------------- -------------
Total capitalization ............................................ $ 3,858,895 $ 38,838,895
============= =============
</TABLE>
The table does not reflect the issuance of 400,000 shares of common stock
in July 1999.
The outstanding share information excludes the following:
/bullet/ 905,250 shares of common stock issuable on exercise of outstanding
options as of June 30, 1999 with a weighted average exercise price
of $6.36 per share;
/bullet/ 132,534 shares of common stock reserved for grant and issuance
under our stock option plans as of June 30, 1999; and
/bullet/ 80,977 shares of common stock held in treasury as of June 30,
1999.
This table should be read together with the sections entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Use of Proceeds" and "Management--Employee Benefit Plans" and the
financial statements and the notes included elsewhere in this prospectus.
18
<PAGE>
DILUTION
Our net tangible book value as of June 30, 1999 was approximately $3.1
million, or approximately $0.25 per share. Net tangible book value per share
represents the amount of our total tangible assets less total liabilities,
divided by the total number of shares of our common stock outstanding. Net
tangible book value excludes the $3.2 million of proceeds we realized upon the
sale of our common stock in July 1999, net of expenses.
Net tangible book value dilution per share to new investors represents the
difference between the amount per share paid by purchasers of shares of common
stock in this offering and the net tangible book value per share of common
stock immediately after completion of this offering. After giving effect to our
sale of 3.0 million shares of common stock in this offering at an initial
offering price of $13.00 per share and after deducting the estimated
underwriting discounts and commissions and estimated offering expenses and the
application of the estimated net proceeds, our net tangible book value as of
June 30, 1999 would have been $38.1 million or $2.52 per share. This represents
an immediate increase in net tangible book value of $2.27 per share to existing
stockholders and an immediate dilution of $10.48 per share to purchasers of
common stock in the offering, as illustrated in the following table:
<TABLE>
<S> <C> <C>
Initial public offering price per share ..................................... $ 13.00
Net tangible book value per share as of June 30, 1999 ...................... $0.25
Increase in net tangible book value per share attributable to new investors 2.27
-----
Net tangible book value per share after the offering ........................ 2.52
--------
Dilution per share to new investors ......................................... $ 10.48
========
</TABLE>
The following table summarizes, as of June 30, 1999, the differences
between existing stockholders and the new investors with respect to the number
of shares of common stock purchased from SmartDisk, the total consideration
paid and the average price per share paid, before deducting the underwriting
discounts and commissions and estimated offering expenses payable by SmartDisk.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------------ -------------------------
NUMBER PERCENT AMOUNT PERCENT
------------ --------- -------------- --------
<S> <C> <C> <C> <C>
Existing stockholders ......... 12,123,511 80% $28,659,371 42%
New stockholders .............. 3,000,000 20 39,000,000 58
---------- -- ----------- --
Totals ...................... 15,123,511 100% $67,659,371 100%
========== === =========== ===
</TABLE>
The foregoing discussion and tables assume no exercise of any stock
options outstanding as of June 30, 1999. As of June 30, 1999, there were
options outstanding to purchase a total of 905,250 shares of common stock with
a weighted average exercise price of $6.36 per share. To the extent the options
are exercised, there will be an additional dilution to new investors. See
"Management--Employee Benefit Plans," "Description of Capital Stock," and
note 8 of notes to financial statements.
19
<PAGE>
SELECTED FINANCIAL DATA
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The selected financial data of SmartDisk as of and for each of the three
years in the period ended December 31, 1998, and as of and for the six months
ended June 30, 1999, have been derived from SmartDisk's audited consolidated
financial statements included in this prospectus. The selected financial data
of SmartDisk as of and for each of the two years in the period ended December
31, 1995, have been derived from unaudited consolidated financial statements
not included in this prospectus. The selected financial data of SmartDisk as of
and for the six months ended June 30, 1998, have been derived from unaudited
consolidated financial statements included in this prospectus and contain all
adjustments, consisting only of normal recurring accruals, which SmartDisk
believes are necessary for a fair statement of SmartDisk's financial position
and results of operations for that period. The financial information for the
six months ended June 30, 1999 may not be indicative of the results that may be
expected for the entire fiscal year ending December 31, 1999. The following
selected financial data should be read together with the "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the financial statements and notes beginning on page F-1 of this prospectus.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------------------------
1994 1995 1996 1997 1998
------------- ------------- ------------ ----------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Product sales .......................... $ 102 $ 316 $ 500 $ 893 $ 15,038
Royalties .............................. -- -- -- -- 285
-------- -------- --------- -------- --------
Total revenues .......................... 102 316 500 893 15,323
Cost of revenues ........................ 68 486 367 301 12,600
-------- -------- --------- -------- --------
Gross profit (loss) ..................... 34 (170) 133 592 2,723
Operating expenses:
Research and development ............... 499 331 720 1,412 1,608
Sales and marketing .................... 47 48 6 12 2,547
General and administrative ............. 546 1,728 3,418 3,184 4,149
Impairment loss ........................ -- -- 7,807 -- --
-------- -------- --------- -------- --------
Total operating expenses ................ 1,092 2,107 11,951 4,608 8,304
-------- -------- --------- -------- --------
Operating loss .......................... (1,058) (2,277) (11,818) (4,016) (5,581)
Gain (loss) on foreign exchange ......... -- -- -- -- (48)
Interest and other income ............... -- 38 -- 8 76
Interest expense ........................ -- -- -- (1) (52)
-------- -------- --------- --------- --------
Net loss before income taxes ............ (1,058) (2,239) (11,818) (4,009) (5,605)
Income tax expense (benefit) ............ -- -- (2,348) (45) (102)
-------- -------- --------- -------- --------
Net loss ................................ $ (1,058) $ (2,239) $ (9,470) $ (3,964) $ (5,503)
======== ======== ========= ======== ========
Net loss per share(1) ................... $ (0.14) $ (0.30) $ (1.25) $ (0.51) $ (0.68)
Shares used in computing net loss
per share(2) .......................... 7,350 7,350 7,579 7,739 8,040
<PAGE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
-----------------------
1998 1999
------------ ----------
(UNAUDITED)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Product sales .......................... $ 3,790 $ 13,797
Royalties .............................. 182 196
--------- --------
Total revenues .......................... 3,972 13,993
Cost of revenues ........................ 3,252 10,271
--------- --------
Gross profit (loss) ..................... 720 3,722
Operating expenses:
Research and development ............... 685 2,454
Sales and marketing .................... 731 1,443
General and administrative ............. 2,086 1,971
Impairment loss ........................ -- --
--------- --------
Total operating expenses ................ 3,502 5,868
--------- --------
Operating loss .......................... (2,782) (2,146)
Gain (loss) on foreign exchange ......... (2) 30
Interest and other income ............... 64 52
Interest expense ........................ (47) (24)
--------- --------
Net loss before income taxes ............ (2,767) (2,088)
Income tax expense (benefit) ............ (38) 68
--------- --------
Net loss ................................ (2,729) (2,156)
========= ========
Net loss per share(1) ................... (0.35) $ (0.24)
Shares used in computing net loss
per share(2) .......................... 7,774 9,043
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------- JUNE 30,
1994 1995 1996 1997 1998 1999
----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents ................... $ 76 $ 51 $ 8 $ 330 $ 2,920 $ 1,335
Working capital (deficit) ................... (1,468) (3,579) (2,191) (4,753) 2,869 1,125
Total assets ................................ 1,054 437 250 1,607 11,136 15,439
Long-term debt (including current portion) .. -- -- 93 645 643 --
Redeemable common stock ..................... -- -- -- -- 9,992 9,992
Total stockholders' deficit ................. (1,400) (3,580) (2,017) (4,626) (6,336) (6,133)
</TABLE>
- -------
(1) Basic and diluted net loss per share are the same for all periods
presented.
(2) Shares used in computing net loss per share reflect the retroactive
adjustment of outstanding shares related to the mergers of SmartDiskette
Limited and SmartDisk Security Corporation into SmartDisk.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF OUR FINANCIAL CONDITION AND RESULTS OF
OPERATIONS SHOULD BE READ TOGETHER WITH OUR FINANCIAL STATEMENTS AND THE NOTES
TO THOSE STATEMENTS INCLUDED IN THIS PROSPECTUS.
COMPANY BACKGROUND
SmartDisk Corporation was incorporated in March 1997 and commenced
operations in January 1998. From May 1993 until May 1998, we conducted
operations primarily through our predecessor, SmartDisk Security Corporation,
or SDSC. SDSC became a wholly owned subsidiary of SmartDisk in May 1998 and was
merged into SmartDisk in June 1998. Moreover, during 1996 and 1997, Fischer
International Systems Corporation, a company controlled by our principal
stockholder and Chairman of the Board, conducted all of SDSC's operations and
development activities pursuant to an operating agreement. Most of our 1996
expenses related to our acquisition and development activities for a product
that was eventually abandoned in late 1996. Moreover, in 1997, we were
primarily a development stage company with limited revenues. We did not begin
to recognize significant revenues from our Smarty and FlashPath products until
mid-1998. Because of these significant fluctuations in our product mix and the
development stage nature of our operations prior to mid-1998, we do not believe
that period-to-period comparisons of our historical results are meaningful or
predictive of future performance. For additional information, see "Certain
Transactions" and note 1 of the notes to our financial statements.
OVERVIEW
SmartDisk designs and develops products that enable consumers to easily
share digital data among advanced consumer electronic products, PCs and the
Internet. We believe that our products provide an easy-to-use, cost-effective
and versatile solution for the exchange of digital data. FlashPath and Smarty,
our patented products, allow consumers to use the well-known 3.5 inch floppy
drive, which is found on most PCs worldwide, to simplify the exchange of
images, music, voice and other digital data.
Our present FlashPath product is mainly used to transfer images to PCs
from digital cameras using the SmartMedia flash memory card. Cameras made by a
number of leading camera manufacturers, including Agfa, FujiFilm, Olympus,
Polaroid, Ricoh, Sanyo, Sharp and Toshiba, utilize SmartMedia cards. During the
12-month period ended June 30, 1999, we sold over 700,000 FlashPaths.
We are currently developing, with Sony and SanDisk, additional FlashPath
products to support their flash memory cards--the Memory Stick and the
MultiMediaCard. These flash memory cards are anticipated to have applications
in "smart" cellular phones, digital cameras and camcorders, digital audio
players and video game devices. FlashPath is also capable of transferring
digital music downloaded from the Internet to the Diamond Rio MP3 audio player.
In addition to our product development efforts with Sony and SanDisk, we also
have strategic relationships with a number of important electronics industry
players, including Hitachi, NEC and Toshiba. They actively participate in the
development of our product pipeline, provides us with access to leading-edge
manufacturing capabilities, and market and distribute our products globally.
RESULTS OF OPERATIONS
GENERAL
Today, substantially all of our revenues are derived from the sale of our
FlashPath product that works with SmartMedia flash memory cards. Moreover, most
of our revenues are derived from sales to relatively few OEM customers.
FujiFilm and Olympus collectively accounted for approximately 70.6% of our 1998
revenues and our top five customers accounted for approximately 92.8% of our
21
<PAGE>
revenues. Our OEM customers generally package, market and distribute our
products on a stand-alone basis, with approximately 25% of our sales being
derived from the sale of products that are packaged with the OEMs' cameras or
that are shipped upon presentation of a coupon that is provided, and paid for,
by the OEM. Although we work closely with the OEMs to forecast sales, we do not
have purchase contracts with any of our customers that obligate them to
continue to purchase our products, and they could cease purchasing products
from us at any time.
Our operating results fluctuate based on the timing and amount of orders
we receive from our customers and depend on the ability of OEMs to achieve
consumer acceptance of our products. This acceptance rate may in turn be tied
to seasonal demand for the consumer electronic products manufactured and sold
by these OEMs. Because fluctuations in orders from our major customers could
cause our net revenues to fluctuate significantly in any given quarter or
annual period, we do not believe that period-to-period comparisons of our
financial results are necessarily meaningful and should not be relied upon as
an indication of future performance. In addition, historically the average
selling prices of our products have declined and we expect that our OEM
customers may seek price concessions, which would reduce our average selling
prices and our gross margins in the future.
Our net losses have resulted from our significant investment in our
research and development and in building sales and marketing and general and
administrative infrastructure. These expenses have exceeded our gross profits.
We expect to continue to invest significantly in research and development
related to new and refined FlashPath products, as well as marketing and sales
activities to support those products, in each case in advance of realizing
revenues associated with those expenses. No assurance can be given that the
introduction or market acceptance of new products will be successful.
We purchase our products from contract manufacturers located in Asia. As a
result, a substantial portion of our costs and expenses are denominated in
currencies other than the U.S. dollar, primarily the Japanese yen. In addition,
approximately 90% of our 1998 revenues were derived from customers located
outside the United States, most of which were denominated in yen. See note 11
of the notes to our financial statements for additional information with
respect to our foreign operations.
While most of the transactions and accounts of our Japanese operations are
yen denominated, some are U.S. dollar denominated. Since the accounting records
of our Japanese operations are kept in yen, those dollar denominated
transactions are accounted for in yen at the time of the transaction. Dollar
denominated accounts are then remeasured at the end of the accounting period.
This remeasurement results in an adjustment to the income of the subsidiary.
Additionally, the balance sheet accounts of our Japanese operations are
translated to dollars for financial reporting purposes and resulting
adjustments are made to stockholders' equity. The value of the yen may
deteriorate against the dollar, which would impair the value of stockholders'
investment in our common stock. Deterioration has occurred in recent years,
resulting in a foreign currency loss of approximately $48,000 and a foreign
currency translation gain adjustment to equity of approximately $290,000 for
1998. For the first six months of 1999, we had a foreign currency gain of
approximately $30,000 and a foreign currency translation loss adjustment of
approximately $5,000. We could be required to denominate our product sales in
other currencies in the future, which would make the management of currency
fluctuations more difficult and expose us to greater currency risk. We do not
currently hedge against foreign currency exposure. If our Japanese operations
were to repatriate earnings to us, the lack of a hedging program would expose
us to an increased risk of foreign currency losses.
Our backlog at June 30, 1999 was approximately $11.1 million, compared to
approximately $4.6 million at June 30, 1998. The increase in backlog of
approximately $6.5 million was primarily caused by increased demand for our
FlashPath product from FujiFilm and Olympus, our major OEM customers, and from
Hagiwara, one of our distributors. However, a substantial portion of our
backlog is typically scheduled for delivery within 60 days. Variations in the
size and delivery schedules of purchase orders received by us, as well as
changes in customers' delivery requirements, may result in substantial
fluctuations in backlog from period to period. Accordingly, we believe that
backlog cannot be considered a meaningful indicator of future financial
results.
22
<PAGE>
SIX MONTHS ENDED JUNE 30, 1999 AND 1998
REVENUES. Our product revenues from the sale of our FlashPath and Smarty
products are recognized at the time of shipment to customers. Our royalty
revenues consist of royalties earned on the sales of our first product,
SafeBoot, which is licensed to and sold by Fischer International, an affiliate.
Our total revenues were approximately $14.0 million in the first half 1999,
compared to approximately $4.0 million in the first half of 1998. This increase
was attributable to the commercial introduction of our FlashPath product in
mid-1998, partially offset by an approximately $300,000 decrease in our Smarty
sales. As a result of the growth of our FlashPath revenues and the decrease in
Smarty sales, Smarty revenues represented less than 4% of total revenues in the
first half of 1999.
COST OF REVENUES. Cost of revenues includes the purchased cost of product,
packaging, freight and royalties for our FlashPath and Smarty products, the
creation of disks for our SafeBoot product and scrap and inventory provisions.
Cost of revenues increased to approximately $10.3 million in the first half of
1999 from approximately $3.3 million in the first half of 1998, due primarily
to the increase in production and sales of our FlashPath product.
GROSS PROFIT. Our gross profit increased to approximately $3.7 million in
the first half 1999 from approximately $700,000 in the comparable 1998 period,
resulting from FlashPath revenue growth.
RESEARCH AND DEVELOPMENT EXPENSES. Our research and development expenses
consist primarily of salaries and payroll-related expenses for our design and
development engineers, as well as prototype supplies and contract or
professional services. These expenses increased to approximately $2.5 million
in the first half of 1999 from approximately $700,000 in the first half of
1998. Approximately $1.0 million of this increase was attributable to the
outsourcing of product development and approximately $600,000 to the hiring of
additional technical personnel. All of these expenses were to support our
development of enhanced versions of our existing FlashPath and Smarty products,
as well as our development of a new FlashPath product designed to work with the
Sony Memory Stick and the SanDisk MultiMediaCard. We expect that our research
and development expenses will continue to increase in connection with the
development of our future FlashPath products.
SALES AND MARKETING EXPENSES. Sales and marketing expenses include
salaries, benefits and travel expenses for our marketing and product management
personnel in the United States and Japan. These expenses also include other
selling and marketing expenditures for items such as trade shows, marketing and
promotional programs. Sales and marketing expenses increased to approximately
$1.4 million in the first half of 1999 from approximately $700,000 in the
comparable 1998 period. Approximately $400,000 of this incease was attributable
to the staffing, including salaries and related expenses, of our Tokyo, Japan
office, which was established in March 1998, approximately $100,000 to
additions in our sales and marketing staff and related expenses at our
headquarters office in Florida, and approximately $200,000 to promotional
programs, including travel and related expenses.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
include the salaries and related expenses of our executive management, finance,
information systems, human resources, legal and administrative functions, as
well as lease rental expense, utilities, maintenance expenses, taxes,
insurance, legal and accounting professional fees, depreciation and
amortization. General and administrative expenses decreased to approximately
$2.0 million in the first half of 1999 from approximately $2.1 million in the
first half of 1998, due to an approximately $300,000 decrease in relocation
expenses, professional services and legal fees, partially offset by increased
staffing costs of approximately $200,000.
GAIN (LOSS) ON FOREIGN EXCHANGE. Most of our revenues, as well as related
expenses, are denominated in Japanese yen. Gain (loss) on foreign exchange
generally reflects the remeasurement of cash and inter-company accounts that
are denominated in different currencies into U.S. dollars. We had a gain of
approximately $30,000 in the first half of 1999 compared to a loss of
approximately $2,000 in the first half of 1998. See note 2 of the notes to our
financial statements for additional information.
23
<PAGE>
PROVISION FOR INCOME TAXES. We are subject to tax in Japan and a number of
other jurisdictions where we do business, including the United States and
United Kingdom. These jurisdictions have different marginal tax rates. For the
period ended June 30, 1999 we provided for Japanese withholding tax of
approximately $130,000 on royalty income from Japan. In addition, income tax
benefits of approximately $38,000 and $63,000 were realized in the June 30,
1998 and 1999 periods due to amortization of intangible assets. As of June 30,
1999 we had a net operating loss carry forward of approximately $6.1 million
for United States federal income tax purposes. However, we have provided a
valuation allowance to reduce the related deferred tax asset to zero. See note
10 of the notes to our financial statements for additional information.
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
REVENUES. Our revenues increased to approximately $15.3 million in 1998
from $893,000 in 1997 and $500,000 in 1996. The increase from 1997 to 1998 was
due to an approximately $13.4 million increase in sales of our FlashPath
product and a $1.0 million increase in sales of Smarty. Substantial shipments
of these products did not occur until the first quarter of 1998 for Smarty and
the second quarter of 1998 for FlashPath. The only product shipped in all three
years was SafeBoot. During 1996 approximately $277,000 of our Crypto-SmartDisk
product was shipped. This product was specifically developed and produced for
the United States General Services Administration and was expected to be a high
volume product, but significant orders never developed and the product was
abandoned in late 1996. Because of these significant fluctuations in our
product mix and the development stage nature of our operations prior to
mid-1998, we do not believe that period-to-period comparisons of our historical
results are meaningful or predictive of future performance.
GROSS PROFIT. Gross profit increased to approximately $2.7 million in 1998
from $592,000 in 1997 and $134,000 in 1996. The increase in gross profit was
due to increasing revenues caused especially by the market introduction of the
Smarty product in late 1997 and the FlashPath product in mid-1998. Gross profit
as a percentage of revenues increased from 26.7% in 1996 to 66.3% in 1997 as a
result of increased sales of our SafeBoot product at very high margins, plus
the initial sales of FlashPath and Smarty at high margins. Gross profit as a
percentage of revenues decreased to 17.8% in 1998 as a result of lower overall
margins due to the sales of FlashPath at quantity pricing levels to major
customers. The margins generated in 1996 and 1997 were unrealistically high and
could not be maintained with increases in volume sales to large customers.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased to $1.6 million in 1998 from $1.4 million in 1997 and $720,000 in
1996. The increases were attributable to the hiring of additional technical
personnel to support the development of our FlashPath and Smarty products.
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased to
$2.5 million in 1998 from $12,000 in 1997 and $6,000 in 1996. These increases
were due to the hiring of sales, marketing and product management personnel to
support our FlashPath and Smarty products, particularly the opening of our
Tokyo, Japan office in March 1998.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased to approximately $4.1 million in 1998 from $3.2 million in 1997 and
$3.4 million in 1996. The increase from 1997 to 1998 was attributable to our
hiring of additional executives to support our growth, including executives to
staff our Tokyo office which opened in March 1998. The decrease from 1996 to
1997 was attributable to the abandonment of our Crypto-SmartDisk business.
IMPAIRMENT LOSS. As discussed in more detail in note 5 of the notes to our
financial statements, in 1996 we incurred an approximately $7.8 million
impairment loss. The loss related to the acquisition by one of our affiliates
of a business that was primarily based on the future potential of one product,
Crypto-SmartDisk. This product was specifically being developed and produced
for the United States General Services Administration and was expected to be a
high volume product. However, significant orders never developed and the
product was eventually abandoned in late 1996.
24
<PAGE>
QUARTERLY RESULTS
The following table sets forth unaudited quarterly operating data for each
of the six quarters ended June 30, 1999. In the opinion of management, these
data have been prepared substantially on the same basis as the audited
financial statements appearing elsewhere in this prospectus, and include all
adjustments, consisting only of normal recurring adjustments, necessary for a
fair presentation of the data. However, our operating results have fluctuated
significantly in the past and we expect that they will continue to fluctuate in
the future. Future fluctuations may be a result of a variety of factors,
including the timing and amount of orders we receive from our customers,
reductions in average selling prices, the timing and level of our research and
development expenditures, and the availability of manufacturing capacity
necessary to make our products. Therefore, we believe that period-to-period
comparisons of our historical results are neither meaningful nor predictive of
our future performance. The quarterly data should be read together with the
financial statements and the notes to those statements appearing elsewhere in
this prospectus.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
---------------------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1998 1998 1998 1998 1999 1999
----------- ---------- --------------- -------------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Revenues ......................... $ 532 $ 3,440 $ 4,889 $ 6,462 $ 5,507 $ 8,486
Gross profit ..................... 91 629 1,520 483 836 2,886
Gross profit margin .............. 17% 18% 31% 7% 15% 34%
Total operating expenses ......... 1,297 2,205 2,187 2,615 2,831 3,037
Operating loss ................... 1,206 1,576 667 2,132 1,995 151
Net loss ......................... $1,189 $ 1,540 $ 690 $ 2,084 $ 1,967 $ 189
</TABLE>
Our revenues fluctuated on a quarter-to-quarter basis during the periods
presented primarily because we were in the early stages of our development:
/bullet/ Substantial shipments of our FlashPath product did not commence
until the second quarter of 1998, and our operating expenses in
that quarter increased significantly as a result of our hiring
additional personnel to support our growth.
/bullet/ The increase in our revenues from the second to third quarter of
1998 was primarily attributable to a 30% increase in unit sales of
our FlashPath product and, to a lesser extent, a 16% increase in
the average selling price of that product. These increases resulted
in significantly higher gross profit and gross profit margin for
the third quarter.
/bullet/ The increase in our revenues from the third to fourth quarter of
1998 was primarily attributable to a 55% increase in FlashPath unit
sales in connection with the holiday selling season, partially
offset by a 14% decline in average selling prices instituted by us
in order to gain market share. Our gross profit and gross profit
margin decreased as a result of this decrease in average selling
price, as well as a $400,000 write-down of inventories related to
the introduction of the eight megabyte SmartMedia card and a
$300,000 write-off of unamortized tooling costs associated with the
first version of our FlashPath product.
/bullet/ The decrease in our revenues from the fourth quarter of 1998 to
the first quarter of 1999 was primarily attributable to a 12%
decrease in FlashPath unit sales, reflecting the drop in demand
following the holiday selling season, and a 6% decrease in average
selling price.
/bullet/ The increase in our revenues from the first to second quarter of
1999 was primarily attributable to a 70% increase in FlashPath unit
sales, partially offset by an approximately 5% decrease in average
selling price.
As a result of our extremely limited operating history, we do not have
historical financial data for a significant number of periods on which to base
planned operating expenses. Our expense levels are based in part upon our
expectations concerning future revenue and, to an extent, are fixed. Quarterly
revenues and operating results depend substantially upon the timing and amount
of orders we receive
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from our relatively small number of customers, which may be tied to seasonal
demand for the consumer electronic products manufactured and sold by these
OEMs. Accordingly, the cancellation or delay of customer orders, or the loss of
a significant customer, could have a material adverse effect on our business.
We may be unable to adjust spending for our research and development or other
activities in a timely manner to compensate for any unexpected revenue
shortfall, and any significant shortfall in revenue in relation to our
expectations would have an immediate adverse effect on our business, results of
operations and financial condition.
Due to the above factors, quarterly revenues and results of operations are
difficult to forecast, and we believe that period-to-period comparisons of our
operating results are neither meaningful nor predictive of future performance.
In one or more future quarters our results of operations may fall below the
expectations of securities analysts and investors. In that event, the trading
price of our common stock would likely be materially adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
In 1996 and 1997, we financed our operations principally through loans
payable to related parties. During 1998 and 1999, we financed our operations
and repaid loans outstanding through short-term borrowings and the sale of
equity securities in private placements with several strategic investors
including Hitachi, NEC, Rohm, Toshiba and Yamaichi. At June 30, 1999, we had
working capital of approximately $1.1 million and approximately $1.3 million of
cash and cash equivalents.
To date, we have experienced negative cash flows from operating
activities. Net cash used in operating activities was approximately $6.0
million in 1998 and approximately $3.4 million in the first half of 1999. Cash
used in operating activities in 1998 was primarily attributable to a net loss
of approximately $5.5 million, a $3.8 million increase in accounts receivable
and a $1.4 million increase in inventories, partially offset by a $4.0 million
increase in accounts payable and accrued liabilities. Cash used in operating
activities for the first six months of 1999 primarily resulted from a $2.2
million net loss and a $5.2 million increase in accounts receivable, partially
offset by a $1.3 million decrease in inventories and a $2.6 million increase in
accounts payable and accrued liabilities. Our accounts receivable and days
sales outstanding increased significantly from 1998 to the first half of 1999,
because of dramatic growth in sales of our FlashPath product, the majority of
which occurred in Japan. At June 30, 1999 approximately $3.5 million, or 39%,
of our accounts receivable, substantially all of which related to sales to
Asian OEMs, were subject to extended payment term arrangements secured by
promissory notes. This is a normal business practice in Asia, particularly in
Japan, and, in these cases, credit terms generally range from 90 to 150 days.
The OEMs are required to pay for the products that they order from us and which
we deliver to them whether or not they ultimately resell the products. Product
returns are contractually required only for defective products and, to date,
returns have been negligible. In addition, our allowance for doubtful accounts
at June 30, 1999 was minimal in relation to the value of the accounts
receivable, but we believe it to be adequate because the majority of our
revenues are derived from sales in Japan to "blue chip" customers, who either
secure the accounts receivable with a promissory note or have historically
consistently paid without default.
Net cash used in investing activities of $2.1 million in 1998 was
attributable to approximately $1.0 million of capital expenditures, primarily
production equipment for the manufacture of our products, and our approximately
$1.1 million time deposit that collateralizes our credit facility. Net cash
used in investing activities in the first half of 1999 was $1.7 million, all of
which was attributable to our purchases of property and equipment, primarily
production equipment for an enhanced version of our FlashPath for SmartMedia
product. Although we have no commitments, we expect that we will spend up to
approximately $3.0 million for capital expenditures over the next 12 months to
acquire production equipment for the products we are currently developing,
particularly the FlashPaths for the Sony Memory Stick and the SanDisk
MultiMediaCard.
Net cash provided by financing activities totaled approximately $10.4
million in 1998 and consisted primarily of proceeds from our issuance of common
stock and short-term borrowings under
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our credit facility, partially offset by the repayment of certain loans to
affiliates. Net cash provided by financing activities was approximately $3.5
million in the first half of 1999 and consisted primarily of proceeds from our
issuance of common stock and short-term borrowings. We have an approximately
$2.5 million credit facility with a Japanese bank that permits borrowings based
upon our time deposits and the accounts receivable of specified customers.
Borrowings under the facility bear interest at 1.375% per year and mature
December 1999.
We believe that the net proceeds of this offering, along with cash on
hand, will be sufficient to meet our working capital and anticipated capital
expenditure needs for at least the next 12 months. Thereafter, we may require
additional sources of funds to continue to support our business. The capital,
if needed, may not be available or may not be available on terms acceptable to
us.
YEAR 2000 ISSUES
The "Year 2000 Issue" refers generally to the problems that some software
may have in determining the correct century of the year. Many existing
electronic systems, including computer systems, use only the last two digits to
refer to a year. Therefore, these systems may recognize a date using "00" as
1900 rather than the year 2000. If not corrected, these electronic systems
could fail or create erroneous results when addressing dates on and after
January 1, 2000.
In assessing the effect of the Year 2000 Issue on SmartDisk, we determined
that we need to evaluate four general areas:
/bullet/ Supplier relationships;
/bullet/ Internal infrastructure;
/bullet/ Products sold to customers; and
/bullet/ Other third-party relationships.
MANUFACTURER AND SUPPLIER RELATIONSHIPS. We outsource the manufacturing of
our products to a number of subcontractors. If our subcontractors are affected
by the Year 2000 Issue, our supply of products could be delayed or eliminated.
Any disruption in our supply of products from our subcontractors would
seriously harm our business, financial condition and results of operations. We
are currently seeking assurances from our subcontractors that their
manufacturing of our products will be unaffected by the Year 2000 Issue but
have not received assurances to date.
INTERNAL INFRASTRUCTURE. The Year 2000 Issue could also affect our
internal systems, including both our information technology and non-information
technology systems. We have completed an assessment of our material internal
information technology systems, including third-party software and hardware
technology. In addition, we are currently in the process of implementing
changes to our network and workstation software and hardware for our
information technology internal systems to make them Year 2000 ready. We have
also completed an assessment of our non-information technology internal
systems, such as our test facility, and we are currently in the process of
implementing changes to make them Year 2000 ready. We expect to have all
changes to our information and non-information technology internal systems
completed by the end of September 1999. We do not currently have a remediation
plan for non-compliant or possibly non-compliant information technology
systems.
PRODUCTS SOLD TO CUSTOMERS. Our FlashPath and Smarty products do not
contain two digit date codes and therefore are generally unaffected by the Year
2000 Issue. However, once shipped, our products are used in conjunction with
products which we do not develop. The performance of our products could be
affected if a Year 2000 Issue exists in a different component of a customer's
product. We have not, and will not, assess the existence of these potential
problems in our customers' products.
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We do not currently have any information concerning the Year 2000
compliance status of our customers. Our current or future customers may incur
significant expenses to achieve Year 2000 compliance. If our customers are not
Year 2000 compliant, they may experience significant costs to remedy problems,
or they may face litigation costs. In either case, Year 2000 issues could
reduce or eliminate the budgets that current or potential customers could have
for purchases of our products and services. As a result, our business, results
of operations or financial condition could be materially adversely affected.
OTHER THIRD-PARTY RELATIONSHIPS. We rely on outside vendors for utilities
and telecommunication services as well as climate control, building access and
other infrastructure services. We are not capable of independently evaluating
the Year 2000 compliance of the systems utilized to supply these services. We
cannot assure you that these suppliers will resolve any or all Year 2000 Issues
with these systems before the occurrence of a material disruption to our
business. Any failure of these third parties to resolve Year 2000 Issues with
their systems in a timely manner could have a material adverse effect on our
business, financial condition or results of operations.
We have not developed a contingency plan to address situations that may
result if we are unable to achieve Year 2000 readiness of our critical
operations, and we do not plan to do so in the future. Any investigations we
have undertaken with respect to Year 2000 Issues have been funded from
available cash, and these costs have not been separately accounted for. To
date, these costs have not been significant.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement
Number 133, Accounting for Derivative Instruments and Hedging Activities. We
expect to adopt the new statement effective January 1, 2001. The statement will
require us to recognize all derivatives on our balance sheet at fair value. We
do not anticipate that the adoption of the statement will have a significant
effect on our results of operations or financial position.
28
<PAGE>
BUSINESS
OVERVIEW
SmartDisk designs and develops products that enable consumers to easily
share digital data among advanced consumer electronic products, PCs and the
Internet. Consumers are increasingly relying on the transfer of digital
information between electronic devices as an important part of their daily
lifestyles. We believe that our products provide an easy-to-use, cost-effective
and versatile solution for the exchange of digital data. Our patented products,
FlashPath and Smarty, allow consumers to use the familiar 3.5 inch floppy
drive--found on most PCs worldwide--to simplify the exchange of images, music,
voice and other digital data.
Our current FlashPath product is used primarily to transfer images to PCs
from digital cameras using the Toshiba SmartMedia flash memory card. SmartMedia
cards are used in cameras made by a number of leading camera manufacturers,
including Agfa, FujiFilm, Olympus, Polaroid, Ricoh, Sanyo, Sharp and Toshiba.
During the 12-month period ended June 30, 1999, we sold over 700,000
FlashPaths.
We are currently developing, with Sony and SanDisk, additional FlashPath
products to support their flash memory cards--the Memory Stick and the
MultiMediaCard. These flash memory cards are expected to have applications in
"smart" cellular phones, digital cameras and camcorders, digital audio players
and video game devices. FlashPath is also capable of transferring digital music
downloaded from the Internet to the Diamond Rio MP3 audio player. In addition
to our product development efforts with Sony and SanDisk, we also have
strategic relationships with a number of key electronics industry players,
including Hitachi, NEC and Toshiba. Our strategic partners actively participate
in the development of our product pipeline, provide us with access to
leading-edge manufacturing capabilities, and market and distribute our products
globally.
INDUSTRY OVERVIEW
Consumer lifestyles are being transformed by the increasing use of digital
information in the home and workplace. Individuals increasingly rely upon PCs,
computer networks and the Internet to access digital information for
entertainment and productivity purposes. The proliferation of PCs in both the
home and office, as well as the explosive growth of Internet use, has led to
widespread consumer familiarity with the storage, manipulation, transfer and
management of digital data.
In recent years, digital computing and processing have expanded beyond the
boundaries of desktop computer systems to include a broader array of
sophisticated consumer electronic products. These products are often referred
to as information appliances, or Internet appliances, because they are designed
to provide the features and benefits of one or more Internet applications.
These digital appliances include personal digital assistants, "smart" phones,
Internet screen phones and gaming devices, and NetTVs. We believe that
approximately 5.9 million of these types of digital appliances were shipped in
1998, and that this number will grow to approximately 54.8 million by 2002. A
related digital product, the digital camera, has also achieved significant
commercial success. We believe that approximately 3.1 million digital cameras
were shipped in 1998, and that this number will grow to 19.6 million in 2002.
The convergence of advanced consumer electronic products, PCs and the
Internet offers consumers the opportunity to personalize and exchange digital
data generated from a wide range of sources. This convergence has precipitated
greater demand for connectivity. While significant resources have focused on
increasing the speed and capacity of the connection between PCs and the
Internet, the connection between digital appliances and PCs has yet to achieve
the compatibility, simplicity and convenience sought by consumers.
One of the principal barriers to connectivity is the variety of
non-standardized flash memory cards available in the market today. Flash memory
cards are the miniature devices used by many of the
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emerging consumer electronic products to store digital data. There are
currently four major removable flash memory cards, none of which has emerged as
an industry standard and none of which is compatible or operable with any of
the others:
/bullet/ the Toshiba SmartMedia card;
/bullet/ the SanDisk CompactFlash card;
/bullet/ the SanDisk MultiMediaCard; and
/bullet/ the Sony Memory Stick.
A second major barrier is the current lack of convenient connection
methods. While many consumers have increased their use of digital appliances,
there is still a large group of potential users that has not ventured beyond
desktop PCs because they are intimidated by the inherent difficulty of
connecting digital appliances that have non-conforming interfaces and
difficult-to-master connections. As a result, we believe that the continued
growth of the consumer-oriented digital appliance market will depend in large
part upon the ability of users to conveniently transfer stored digital data
which is captured by digital appliances. For example, the rapid growth of the
digital camera market was based, to a large degree, upon consumers' ability to
easily transfer images to family members and others through the Internet and
manipulate the captured images with their PCs. The popularity of the PalmPilot
was also largely fueled by the ability of consumers to easily connect and
transfer data to and from their PCs. Therefore, one of the principal challenges
faced by manufacturers of consumer digital appliances is the interface between
their appliances and PCs or other digital appliances.
There are currently a number of interfaces used to transfer data from
digital appliances to personal computers:
/bullet/ cable interfaces such as serial ports, the Universal Serial Bus,
or USB, and parallel ports; and
/bullet/ non-cable interfaces such as infrared interfaces and PCMCIA and
floppy disk drive slots.
We believe that most interfaces have disadvantages that make them
impractical for use with consumer-oriented digital appliances. Consumers
typically do not like to use cable connections, such as serial port, USB and
parallel port connections. Those interfaces require the use of limited PC
peripheral ports, which are frequently dedicated to connecting the PC to
devices such as printers, modems, PalmPilots and other peripherals. In
addition, the need to connect a cable to the back of the PC is inconvenient and
often resisted. Other disadvantages of cable interfaces include desktop clutter
and the fact that the newer interfaces such as USB are not present on most
installed PCs. Some of the non-cable interfaces also have inherent limitations.
For example, while virtually all portable PCs being sold today contain a PCMCIA
slot or infrared interface as a standardized feature, we believe that neither
the PCMCIA slot nor the infrared interface is generally available on desktop
computers.
THE SMARTDISK SOLUTION
We design, develop, manufacture and distribute easy-to-use, portable and
low cost devices that facilitate data exchange between digital appliances, PCs
and the Internet. Our patented products connect through the most
widely-accepted and user-friendly PC interface, the 3.5 inch floppy disk drive,
allowing the OEMs that market their and our consumer products to reach a large
installed base of potential users.
Our current and planned FlashPath and Smarty products are designed to
offer the following principal benefits:
EASE OF USE. Our products are easy to use and install. FlashPath transfers
digital data to the PC without cables or hardware installation and without
using limited desktop space or personal computer ports. A consumer using a
digital camera removes the flash memory card that serves as the camera's
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digital film, places that flash memory card into our FlashPath product, and
then inserts the FlashPath into the PC's 3.5 inch floppy disk drive. FlashPath
easily transfers to the PC the images that are captured by the digital camera
and stored on the flash memory card. The consumer can then use the PC to edit
and print the image, add sound or text, transmit the image over the Internet or
incorporate the image in advertisements, newsletters, reports or other
documents produced using the PC.
PRODUCTS COMPATIBLE WITH MULTIPLE MEDIA. We believe that our established
ability to design products that support competing flash memory cards is
critical because of the lack of flash memory industry standards. Our initial
FlashPath product was designed to transfer digital photographs from the Toshiba
SmartMedia card to the PC for transmission over the Internet. Other flash
memory products under development are designed to be compatible with the Sony
Memory Stick and the SanDisk MultiMediaCard. Our ability to design products
compatible with multiple media is enhanced by our strategic relationships with
the three leading manufacturers of flash memory storage cards--SanDisk, Sony
and Toshiba. By supporting various media, we will be able to address the data
transfer needs of purchasers of existing and emerging digital appliances that
use different flash memory cards. In addition, our Smarty product supports
various smart card formats.
FAMILIAR FORM. Our products are shaped like a 3.5 inch floppy disk and use
the floppy disk drive slot familiar to most PC users. This widely recognized
format reduces consumer intimidation frequently created by new technologies,
facilitating the adoption of our products and various consumer-oriented digital
appliances.
VERSATILE. Our FlashPath and Smarty products can be used with a variety of
PC hardware platforms and software environments. Our driver software is
included with our products and can also be downloaded free of charge from the
Internet. The software enables our products to operate with Windows 95, Windows
98, Windows NT, NEC Windows and Macintosh operating systems. As a result, the
same FlashPath that is used by an advertising executive to transfer images from
his Olympus digital camera to his Microsoft-based office PC can be used by his
daughter to transfer images from her FujiFilm camera to her Apple computer.
Similarly, the same FlashPath that is used to transfer images may also be used
to transfer voice and other digital data from a variety of digital appliances
that use the same flash memory card. The versatility of our products will
become more important as consumers increase their reliance on flash memory
cards to store and transfer digital data where traditional memory storage
devices such as floppy disks are inadequate due to capacity or form factor
constraints.
INDEPENDENT POWER SOURCE. Unlike cables, our FlashPath and Smarty products
do not rely upon a digital appliance's power source to transfer digital data
from a flash memory card to a PC. Each of our products runs on two replaceable
batteries. This is important because digital appliances, such as digital
cameras, consume significant amounts of power and require frequent battery
replacement or recharging. The use of cable interfaces quickly drains power
from digital appliances, making those competing products less attractive.
BUSINESS STRATEGY
Our objective is to establish our FlashPath products as the
industry-standard solution for the transfer of data between digital appliances
and PCs by strengthening our position as a technological and market leader. We
also intend to capitalize on the anticipated growth of smart card applications
through our Smarty product line. Key elements of our business strategy include
the following:
CAPITALIZE ON TECHNOLOGY EXPERTISE TO EXPAND OUR PRODUCT OFFERINGS. We
have developed extensive expertise, intellectual property and core capabilities
in flash memory data transfer and smart card technologies. Each of our products
is developed using a building block approach that employs previously developed
technologies. This ability to modify our existing technologies allows us to
quickly respond to industry developments, providing first-to-market advantages
and reducing development costs for future products. We expect to capitalize on
our technology base and patent portfolio to
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<PAGE>
design, develop and manufacture a broad range of data transfer devices that can
operate across a variety of flash memory products, hardware platforms and
software environments. In the short-term, we are developing products to
transfer digital data between PCs and different flash memory cards and are
expanding our applications to support digital audio players. In addition, we
are using our technology expertise, patents and trade secrets to develop
application-specific, non-PC-based devices that will permit flash memory cards
to be used with other existing technologies. We will also strive to capitalize
on our past design experience to develop products that support computer
interfaces other than the 3.5 inch floppy disk drive.
EXPAND CUSTOMER AND STRATEGIC INDUSTRY RELATIONSHIPS. We have formed
strategic relationships with a number of leading consumer product OEMs and
other key industry players, including FujiFilm, Hitachi, NEC, Olympus, SanDisk,
Sony and Toshiba. We intend to continue to develop long-term alliances with a
diversified base of OEMs and other industry participants in additional consumer
electronics segments. We believe that these relationships provide significant
operating leverage and a number of other important benefits:
/bullet/ Our OEM customers advertise, promote, package, sell and distribute
our products under some of the world's most recognized brand names.
These include FujiFilm, Hitachi, Olympus, Polaroid, Sharp and
Toshiba. As a result, we have access to extraordinary market clout
without the need to invest heavily in our own marketing
infrastructure and programs.
/bullet/ Our product development relationships frequently provide access to
flash memory card manufacturers early in the design phase of their
product development process. This allows us to anticipate these
manufacturers' future technological requirements and to develop
long-term relationships across a number of products and through
multiple product generations. In addition, these partners often
assist with engineering and design for manufacturability, which
helps assure that mechanical and electrical considerations are
integrated into a total systems approach to achieve a high quality
and cost-effective product.
MAINTAIN MEDIA NEUTRALITY. We are using our flexible technology
architecture and core capabilities to create products that enable consumers to
use most leading flash memory cards. There is a rapidly growing number of
digital appliances that use competing flash memory technologies, none of which
we currently expect to become an industry standard. We are committed to
maintaining media neutrality to enable users of various leading flash memory
technologies to transfer data quickly and easily among devices that use
different flash memory card formats.
PROMOTE BRAND AWARENESS OF OUR PRODUCTS. Approximately 75% of our products
are packaged, marketed and distributed by OEMs on a stand-alone basis. The
remainder of our products are either packaged with the cameras manufactured by
the OEMs or are shipped by us upon presentation by the consumer of a coupon
that is provided, and paid for, by the OEM. Accordingly, it is critical that we
obtain ultimate consumer acceptance of and demand for our products independent
of sales that occur in conjunction with sales of our OEMs' products. To this
end, we intend to build upon our initial success by promoting the FlashPath and
Smarty brand names. Our brands are often displayed on the packaging of the OEM
products and, as a result, we are able to benefit from the powerful advertising
and promotion of our products by the OEMs while simultaneously building our
brand identity. In addition, we intend to expand our use of advertising and
other marketing programs designed to promote our brand and enhance brand
awareness. We also intend to increase distribution channels for our products by
promoting direct sales via the Internet and through retailers.
EMPHASIZE USER-FRIENDLY PRODUCTS. We are committed to capitalizing on our
patent portfolio to enable consumers to conveniently transfer images, music,
voice and other types of digital data between consumer electronic devices, the
Internet and PCs without hardware installation, cables or the use of PC
peripheral ports.
TECHNOLOGY
Since our inception, we have focused our research and development efforts
on designing and developing products that facilitate the transfer of data from
digital appliances using flash memory
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cards and smart cards to PCs. We have been actively involved in all aspects of
this development process, including the development of a proprietary technology
architecture which supports all of our FlashPath and Smarty products and can be
used as the basis for new products. We believe that our patents provide
substantial proprietary protection relating to the transfer of digital data
through floppy disk interfaces. We also believe that we have developed
particular expertise in research, product design and product development.
Our products are compatible with a broad range of hardware platforms and
software environments. Our floppy disk drive interface architecture builds upon
key elements of our technology, including digital and analog ASICs, driver
software and key mechanical components, and allows us to develop products that
support different flash memory and smart cards. In addition, we believe that
this architecture improves reliability, decreases time to market and lowers new
product development costs. For example, the development of our FlashPath
product for SmartMedia flash memory cards took approximately 18 months from
determining product feasibility to commencing commercial production, and we
expect the time for the development of our products for the MultiMediaCard and
Sony Memory Stick will be shortened to less than 12 months. We believe that we
will take advantage of similar opportunities to utilize our core technological
capabilities as we continue our efforts to develop products to conveniently
transfer digital data from competing flash memory cards to existing, non-PC
technologies and, in the future, products that support computer interfaces
other than the 3.5 inch floppy disk drive.
During the remainder of 1999 and 2000, we expect that our development
efforts will be primarily focused on the following initiatives:
/bullet/ expanding our FlashPath product line to support the Sony Memory
Stick and the MultiMediaCard;
/bullet/ further reducing our production costs;
/bullet/ enhancing product performance; and
/bullet/ developing new, application-specific products that will allow
flash memory cards to be used with existing non-PC technologies.
An element of our business strategy is to enter into strategic alliances
without licensing our technology to OEMs. Our strategic alliances with Hitachi,
NEC, Sony and Toshiba began with their initial inquiries to license our
FlashPath technology. Those preliminary overtures developed into more extensive
dialogues and the exchange of information that permitted us to better
demonstrate our technology platform, proprietary rights and research, design
and development expertise. We believe that the broad scope of our strategic
alliances with these leading industry participants demonstrates the appeal and
strength of our proprietary technology. Many of these alliances have led to
equity investments and cooperative development arrangements.
The technology comprised in our product offerings consists of five key
components:
/bullet/ FLASH MEMORY OR SMART CARD READ/WRITE SYSTEM. This proprietary
system uses the central processing logic to store data on and
retrieve data from the flash memory card in the product.
/bullet/ DIGITAL ASIC. Our proprietary digital ASIC prepares the digital
data to be retrieved from the flash memory, encodes it and sends it
to the analog ASIC. The digital ASIC also decodes data from the
analog ASIC for use with the flash memory or smart card read/write
system.
/bullet/ ANALOG ASIC. Our proprietary analog ASIC converts the digital data
to analog signals for retrieval from the flash memory card.
/bullet/ CENTRAL PROCESSING UNIT. This unit consists of an industry
standard microprocessor, memory and other processing logic to
control the functions of the digital and analog ASICs and the flash
memory or smart card read/write system.
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/bullet/ DRIVER SOFTWARE. Our proprietary driver software enables our
products to operate with a variety of commonly installed personal
computer operating systems such as Microsoft Windows.
MARKETING, CUSTOMERS AND STRATEGIC RELATIONSHIPS
SALES AND MARKETING. We market and sell our current FlashPath product
primarily to OEMs, including Agfa, FujiFilm, Olympus, Polaroid, Ricoh, Sanyo,
Sharp and Toshiba. These OEMs compete in some of the fastest growing segments
of the electronics industry, including digital cameras, digital audio players,
digital camcorders and personal digital assistants.
OEMs sell approximately 75% of our products on a stand-alone basis, and
approximately 25% of our products are sold either packaged with the OEMs'
products or are shipped by us upon presentation of a coupon that is provided,
and paid for, by the OEMs. Often, both the OEM's brand name and our FlashPath
or Smarty tradename appear on the product packaging. As a result, we benefit
from the powerful advertising and promotion of our products by the OEMs without
having to incur significant additional marketing expenses. For example, our
products have been featured in OEM advertisements in major publications,
including THE WALL STREET JOURNAL, TIME MAGAZINE and USA TODAY.
The packaging of our FlashPath product with FujiFilm's and Olympus'
digital cameras illustrates the synergistic relationships we have with some of
our customers. Their marketing campaigns emphasize the convenience of using the
FlashPath product to transfer digital photographs to the PC. We believe that
our FlashPath adapter is one of the key reasons that many of the top selling
digital cameras in the world use Toshiba's SmartMedia card. We shipped
approximately 700,000 FlashPath units during the 12-month period ended June 30,
1999 largely as a result of our customers' extensive market penetration.
We support the marketing activities of our customers with a dedicated
product manager for each of our product lines. In addition, we support their
sales efforts through sales training courses, public relations activities,
trade shows and industry education programs. We also employ marketing
communications personnel to develop packaging, brochures and other collateral
materials.
We market and sell our Smarty product to financial institutions and other
service providers who promote Smarty to their customers as part of their smart
card-based programs. Our Smarty customers include ABN Amro Bank (The
Netherlands), Bally Gaming, Bank of America, la Caixa Bank (Spain) and Visa.
As of August 31, 1999, we had 9 full-time employees engaged in sales and
marketing activities. We also use the services of Japan-based dealers to serve
as our agents in connection with sales to OEMs based in that country. Those
intermediaries generally mark up the selling price to the OEM purchaser by
approximately 3%. Our customers generally place orders for our products on an
as-needed basis, with no long-term commitments.
STRATEGIC RELATIONSHIPS. An important element of our business strategy is
to develop strategic relationships with industry players that can assist us in
the development of new products, provide us with access to leading-edge
manufacturing capabilities and market and distribute our products globally.
This approach allows us to concentrate our resources on our core expertise of
product design and development, reduces our capital requirements and generally
provides a high degree of operating leverage. In addition, our close
relationships with flash memory card manufacturers and consumer product OEMs
frequently provide insight into the current and future needs of these
companies, enabling us to design specific products to meet these needs. OEMs
frequently distribute our FlashPath product in connection with the distribution
of their consumer electronic products. As a result, we believe that these
strategic relationships allow us to take advantage of OEMs' direct sales
organization, distributors and manufacturers' representatives. We evaluate
potential collaborative arrangements on an ongoing basis and intend to continue
to pursue additional strategic relationships.
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Set forth below are brief descriptions of some of our strategic
relationships:
TOSHIBA. Toshiba Corporation, a leading electronics company, played a
critical role in our early development stage. Toshiba made an equity
investment of approximately $10.0 million in SmartDisk and introduced us to
most of the key technical personnel that now constitute our Tokyo-based
applied engineering and production engineering team. Toshiba also assisted
us in the development and engineering of FlashPath, helped guide our
selection of manufacturing techniques, aided our introduction into mass
production and introduced our management to potential strategic partners.
Toshiba continues to provide cooperative support in several areas. For
example, four of their engineers continue to reside in and provide
full-time support to our Tokyo office on a contract basis.
SONY. Under our co-development agreement with Sony, which terminates no
later than March 31, 2000, we are developing a FlashPath product for use
with the Sony Memory Stick. Sony reimburses us for a portion of our
development expenses and pays us additional fees during the course of
development. We expect that we will manufacture, and that Sony will
distribute, the co-developed product.
SANDISK. We also have a co-development agreement with SanDisk, a leading
developer and marketer of flash memory storage products, including
CompactFlash and the MultiMediaCard. Under this arrangement, we are jointly
developing a FlashPath product to support the SanDisk MultiMediaCard. We
are funding the development costs and we will be entitled to revenues
derived from the sale of our FlashPath for the MultiMediaCard. We will pay
SanDisk a royalty based on the portion of those revenues derived from sales
other than to SanDisk. We issued 37,500 shares of our common stock to
SanDisk as partial payment for entering into the co-development agreement.
VISA. We have a non-contractual arrangement with VISA International, a
leading issuer of credit cards, to test our Smarty product. Under the pilot
program, Smarty is used in conjunction with the Visa Platinum card to
permit controlled access to the Visa website, allowing card holders to
access account information and other ancillary services. Since inception of
the program, Visa has purchased and distributed approximately 15,000 Smarty
units.
The following table illustrates the nature of some of our strategic
relationships:
<TABLE>
<CAPTION>
TYPE OF STRATEGIC RELATIONSHIP
--------------------------------------------------------------------------------------------------
ASSISTED IN MANUFACTURER
INVESTED IN PRODUCT PROVIDED SUPPLIER OF OF SMARTDISK CUSTOMER OF
NAME SMARTDISK DEVELOPMENT LICENSE COMPONENTS PRODUCTS SMARTDISK
- ------------------ -------------- -------------- -------------- -------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Atmel ............ /check mark/ /check mark/
Hitachi .......... /check mark/ /check mark/ /check mark/ /check mark/
Mitsumi .......... /check mark/ /check mark/
NEC .............. /check mark/ /check mark/ /check mark/
Rohm ............. /check mark/ /check mark/ /check mark/
SanDisk .......... /check mark/ /check mark/ /check mark/ /check mark/
Sony ............. /check mark/ /check mark/
Toshiba .......... /check mark/ /check mark/ /check mark/ /check mark/
Yamaichi ......... /check mark/ /check mark/ /check mark/ /check mark/
</TABLE>
PRODUCTS
Each of our products is based upon our core, patented technology and is
designed to easily transfer digital data between PCs, the Internet and various
types of digital appliances.
FLASHPATH. FlashPath is a solid state electronic device in the shape of a
3.5 inch floppy diskette. It works in any standard 3.5 inch floppy drive--the
type found in most PCs today. The current
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principal use of our FlashPath product is to transfer images from digital
cameras to PCs. Digital cameras use flash memory cards as film. After the flash
memory card captures and stores images, the flash memory card is removed from
the camera and is placed into FlashPath. FlashPath is then inserted into the
PC's floppy disk drive and the images are transferred to the PC. With the aid
of readily available software, the consumer may then edit the images, add text,
graphics or sound, or mail the images over the Internet. Because FlashPath
transfers images from the camera to the PC without using cables or PC
peripheral ports and without any hardware installation, the consumer has a
device that is familiar, easy to use, not intimidating and transportable among
multiple PCs. FlashPath uses our proprietary driver software provided with our
products and available free of charge from the Internet. Our driver software
enables our products to operate with Windows 95, Windows 98, Windows NT, NEC
Windows and Macintosh operating systems.
Our current FlashPath product transfers images from digital cameras using
the SmartMedia flash memory card manufactured by Toshiba and Samsung. A number
of manufacturers use the SmartMedia card in their digital cameras, including
Agfa, FujiFilm, Olympus, Polaroid, Ricoh, Sanyo, Sharp and Toshiba. During the
12-month period ended June 30, 1999, we sold over 700,000 FlashPath adapters
for SmartMedia cards.
We are also developing two other FlashPath products that use different
flash memory media. One is designed to work with the Sony Memory Stick, which
initially will have applications in digital cameras, and the other is designed
to work with the SanDisk MultiMediaCard, which initially will be used in
conjunction with "smart" cellular telephones being developed by Nokia and
camcorders by JVC. In addition, we expect that these new FlashPath adapters
will support other applications, including digital audio players. We recently
completed production of a limited number of our FlashPath product for the Sony
Memory Stick, and we expect to commercially introduce FlashPath for the Sony
Memory Stick in the fourth quarter of 1999. We are currently in the early
stages of developing a prototype of FlashPath for the SanDisk MultiMediaCard
and we expect to commercially launch that product in the first quarter of 2000.
We expect that these new products will enable us to reach new markets and new
customers. In addition, we are developing a new consumer-oriented product that
is designed to allow flash memory cards to be used with an existing, non-PC
technology.
SMARTY. Our Smarty products enable smart cards to store and retrieve
information through a PC's floppy disk drive, thereby eliminating the need for
dedicated smart card reader peripherals. Like our FlashPath products, the
Smarty product is a solid state electronic device the size of a 3.5 inch floppy
disk, is powered by two replaceable batteries and requires no external power
source or wire connections. Smart cards are inserted into our Smarty product,
which accesses information on the smart card from the card's embedded
microprocessing chip. A user simply places the smart card into Smarty, inserts
Smarty into the 3.5 inch floppy disk drive and connects with the smart card
application. Smarty retrieves data from and stores data on any standard smart
card without cable connections, without any hardware installation and without
consuming PC peripheral ports.
Smart cards are typically used to store information such as medical
information, digital money and security codes. Accordingly, smart cards can
serve as personal identification, a credit card, a mass transit pass and as a
cash substitute for purchases at stores or over the Internet. Smart cards are
used in a number of applications in Europe but, as yet, have not gained
widespread consumer acceptance in the United States. However, we believe that
acceptance is increasing among businesses.
Today, Smarty is primarily being used in pilot programs, the earliest of
which began in October 1997. The major users of Smarty are ABN Amro Bank (The
Netherlands), Bally Gaming, Bank of America, la Caixa Bank (Spain) and Visa.
The product is sold to these customers, who in turn distribute it to their
customers for use with their accounts. Bank of America, for example,
distributes Smarty to some of its corporate customers for use in making secure
electronic funds transfers. Visa distributes Smarty with its Platinum card in
some Latin American regions for use in authenticating permitted access to
restricted areas on the Visa Platinum world wide web site. The pilot programs
have provided us with useful feedback that has resulted in improvements to the
product, but we do
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not expect a significant increase in our Smarty sales in the near future.
Smarty is designed to work with Microsoft's Personal Computer/Smart Card
(PC/SC) standard.
RESEARCH AND DEVELOPMENT
Our product design and development activities are conducted in both our
Naples, Florida and Tokyo, Japan offices.
NAPLES. Our Naples team is primarily responsible for our core research and
development activities, including product conceptualization, software and
firmware development, technical writing, printed circuit board layouts and
mechanical engineering. Our Naples team has significant expertise with floppy
disk drive interfaces, flash memory media and smart card interfaces, driver,
user and utility software interfaces, and design and firmware for ASICs. Our
engineers and other research and development employees also develop design
specifications based on customer requirements and supervise our quality
assurance activities. This 26-person Naples team consists of executive
management, line management, engineers, developers and quality assurance
personnel.
TOKYO. Our Tokyo research and development team actively assists in the
implementation of our product designs, with primary responsibility for applied
engineering, production engineering and the supervision of our contract
manufacturers. Our Tokyo team also plays a principal role in coordinating our
development activities with the leading flash memory card manufacturers and
refining the product requirements of our OEM customers. Other activities
include the localization/translation of our products for the Japanese market,
debugging and quality assurance. Our Tokyo research and development team
consists of our Japanese subsidiary's Vice President of Engineering and four
Toshiba engineers who provide services on a contract basis.
For 1996, 1997, 1998 and the first six months of 1999, our research and
development expenditures were approximately $720,000, $1.4 million, $1.6
million and $2.5 million, respectively.
In addition, since our inception we have endeavored to develop and
maintain close relationships with key suppliers of components and technologies
in order to enable us to quickly introduce new products that incorporate the
latest technological advances. As a result, the substantial resources of
companies such as Hitachi, Mitsumi, NEC, Rohm, SanDisk, Sony, Toshiba and
Yamaichi augment our internal research and development efforts. These
cooperative arrangements take many forms and provide a number of benefits. For
example, SanDisk, Sony and Toshiba have licensed technology to us that allows
our products to interface with their flash memory cards and provide extensive
engineering support. We believe that our close relationships with flash card
manufacturers and consumer product OEMs also provide insight into their current
and future needs, enabling us to design specific products that meet those
requirements.
MANUFACTURING AND SOURCES OF SUPPLY
We currently outsource our manufacturing and plan to continue to outsource
manufacturing for the foreseeable future. This strategy allows us to focus on
our core research, product design and development capabilities, and to reduce
the substantial capital investment required to manufacture our products. We
also believe that our use of experienced, high-volume manufacturers provides
greater manufacturing specialization and expertise, higher levels of
flexibility and responsiveness, and faster delivery of product than in-house
manufacturing. In addition, we frequently seek the advice of our experienced
manufacturers with respect to design changes that reduce manufacturing costs or
lead times or increase the manufacturing yields and the quality of our finished
products.
Our products are currently manufactured in the Philippines at facilities
operated by Yamaichi and Mitsumi. Under our manufacturing arrangements, we
receive fully assembled and tested products based upon our proprietary designs
and specifications. We selected our manufacturers based upon their reputations
for quality, their cost structures, their production capacities and their
support of
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state-of-the-art manufacturing processes and systems. However, our current
dependence on a limited number of manufacturers exposes us to a variety of
risks, including shortages of manufacturing capacity, and reduced control over
delivery schedules, quality assurance, production yields and costs.
Accordingly, we intend to seek additional manufacturing capacity and, in
particular, at least two manufacturers for each of our products. To that end,
in January 1999, we signed an agreement with Hitachi to manufacture our Smarty
product. We expect production by Hitachi to begin by the end of 1999. We do not
have contracts in place with any of our current manufacturers.
To ensure that products manufactured by others meet our standards, our
Tokyo production and engineering team works closely with our contract
manufacturers in all key aspects of the production process. We establish
product specifications, select the components to be used to produce our
products, select the suppliers, and negotiate the prices for most of these
components. We also work with our contract manufacturers to improve process
control and product design, and conduct periodic, on-site inspections of our
manufacturers. In addition, our Tokyo team conducts monthly review meetings
with our manufacturers to discuss sales forecasts and the procurement of long
lead-time parts, production capacities and facilities.
We rely upon a limited number of suppliers of several key components used
in our products. In particular, Rohm manufactures our proprietary ASICs used in
our FlashPath products and our proprietary analog ASICs used in our Smarty
products, and Atmel manufactures our proprietary digital ASICs used in our
Smarty products. Moreover, we purchase ASICs and other components pursuant to
purchase orders placed from time to time and have no guaranteed supply
arrangements. Our reliance on limited source suppliers involves several risks,
including a potential inability to obtain an adequate supply of required
components, unexpected price increases, lack of timely delivery and variable
component quality.
COMPETITION
There are no competitors known to us that offer a digital data transfer
solution for flash memory or smart cards using a 3.5 inch floppy drive.
However, we face competition from numerous providers of cable and other
non-cable interfaces, including ports, USBs and infrared interfaces. These
competing products are offered by a number of companies, including:
/bullet/ in the case of flash memory card interfaces, Hagiwara, SanDisk and
SCM Microsystems; and
/bullet/ in the case of smart card interfaces, Gemplus, Hitachi, SCM
Microsystems and Toshiba.
The market for data transfer products is intensely competitive and
characterized by rapidly changing technology and rapid changes in consumer
preference. We believe that competition is likely to intensify as a result of
increasing demand for digital appliances using flash memory cards. Future
competition may also include flash memory card manufacturers and the consumer
product OEMs that are our current customers. In addition, it is possible that
third parties may design around our patents or license technology to develop
competing products that use a 3.5 inch floppy drive interface.
Many of our current and potential competitors have significantly greater
financial, technical, marketing, purchasing and other resources than we do. As
a result, our competitors may be able to respond more quickly to new or
emerging technologies or standards or 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.
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We believe that the principal competitive factors affecting the market for
flash memory connectivity and smart card products include:
/bullet/ the extent to which products work with existing and will work with
future digital appliances;
/bullet/ ease of use;
/bullet/ quality and reliability;
/bullet/ rate of throughput, or data transfer speed;
/bullet/ strength of distribution channels; and
/bullet/ price.
We believe that our products compete successfully on most of these bases.
INTELLECTUAL PROPERTY
We do not intend to license our proprietary technology to flash memory
card manufacturers, consumer product OEMs or other third parties in the future.
We have granted Fischer International a non-exclusive license to produce our
SafeBoot product until 2001. The protection of our intellectual property rights
is critical to our future success, and we rely in part on patent, trade secret,
trademark, maskwork and copyright law. We own five United States patents and 55
foreign patents. We also have a number of pending patent applications in
various countries. Our patents and patent applications cover various aspects of
our technology.
Although we believe that our patent rights, when considered in conjunction
with our allowed patent applications and trade secret protection, should
prevent another party from manufacturing and selling competing data transfer
products that use a floppy disk drive interface, we cannot guarantee that the
steps we have taken to protect our technology will be successful. The patents
issued to us may not be adequate to protect our proprietary rights, to deter
misappropriation or to prevent an unauthorized third party from copying our
technology, designing around the patents we own or otherwise obtaining and
using our products, designs or other information. In addition, patents may not
be issued under our current or future patent applications, and the patents
issued under those patent applications could be invalidated, circumvented or
challenged. It may also be particularly difficult to protect our products and
intellectual property under the laws of some countries in which our products
are or may be manufactured or sold.
Moreover, third parties could develop technologies that are similar or
superior to our technology or could make infringement claims against us.
Regardless of the outcome, an infringement claim would likely result in
substantial cost and diversion of our resources. In addition, we may not
prevail in litigation or be able to license any valid and infringed patents
from third parties on commercially reasonable terms, if at all. Any
infringement claim or other litigation against us or by us could therefore harm
our business, financial condition and results of operations.
Our FlashPath and Smarty trademarks are registered in the United States
and a variety of other countries in which we do business, and we will continue
to evaluate the registration of additional trademarks as appropriate. However,
we do not have the rights to the Smarty trade name in either Germany or The
Netherlands, and our trademark application for the SmartDisk name is still
pending in the United States. We also claim copyright protection for some of
our proprietary software and documentation. In addition, we generally enter
into confidentiality and non-disclosure agreements with our employees and with
key consultants, vendors and suppliers.
EMPLOYEES
As of August 31, 1999, we had 49 full-time employees, including 27
employees engaged in research and development, 9 engaged in sales and marketing
and 13 engaged in general and
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administrative activities. Our employees are not represented by any collective
bargaining agreements, and we have never experienced a work stoppage. We
believe our employee relations are good.
PROPERTIES
Our corporate and technical headquarters are located in Naples, Florida.
We lease approximately 15,000 square feet of space in Naples, Florida under a
three-year lease which expires in December 2001. We also lease approximately
3,500 square feet of space in Tokyo for our Japanese operations. This lease
expires in April 2000. We believe that our existing facilities are adequate to
support our existing operations and that, if needed, we will be able to obtain
suitable additional facilities on commercially reasonable terms.
LITIGATION
SmartDisk is not a party to any material legal proceedings.
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<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
Our executive officers, directors and key employees, and their ages as of
August 31, 1999, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- --------------------------------- ----- --------------------------------------------------------
<S> <C> <C>
Addison M. Fischer .............. 51 Chairman of the Board of Directors
Michael S. Battaglia ............ 54 President, Chief Executive Officer and Director
Douglas R. Kraul ................ 44 Vice President, Audio/Video Products
Michael R. Mattingly ............ 50 Chief Financial Officer
Robert Protheroe ................ 43 Senior Vice President, Research and Development
Daniel E. Reed .................. 31 Vice President, Corporate Development and Legal Affairs
Quresh Sachee ................... 36 Vice President, Marketing
Yoshiaki Uchida ................. 56 Vice President and General Manager, Asian Operations
D. James Bidzos(1) .............. 44 Director
Anthony A. Ibarguen(2) .......... 39 Director
Shigeki Morita .................. 54 Director
Timothy Tomlinson(2) ............ 49 Director
Hatim Tyabji(1) ................. 54 Director
Joseph M. Tucci(1) .............. 51 Director
</TABLE>
Other Key Employees:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---------------------------- ----- --------------------------------------------------------
<S> <C> <C>
O. Lee Drennan ............. 41 Director of Product Engineering
Kazuhisa Fukatsu ........... 58 Senior Manager, Production Control and Assistant to the
President of SmartDisk International
Kazuhiro Iwata ............. 53 Vice President, Engineering of SmartDisk International
Jon Kaplan ................. 41 Vice President, Software Development
Konosuke Nakamura .......... 52 Vice President, Marketing of SmartDisk International
</TABLE>
- --------
(1) Member of the compensation committee.
(2) Member of the audit committee.
ADDISON M. FISCHER has served as Chairman of the Board of Directors since
our inception in 1997. Mr. Fischer has been an investor in numerous emerging
technology companies as his principal occupation for at least the past five
years. Many of these companies are involved in the fields of computer security
and office automation. He also serves on the board of directors of a number of
companies, including Fischer International Systems Corporation, a
privately-held software company which he controls. He was also a long-time
board member of and significant investor in RSA Data Security, Inc., a leader
in cryptographic software, until its merger in 1996 with Security Dynamics,
Inc. Mr. Fischer also controls Phoenix House Investments, L.L.C., our majority
shareholder. In addition, Mr. Fischer was one of the founders of VeriSign,
Inc., a publicly-held electronic credentials/digital certificate company. Mr.
Fischer is a member of committees that set U.S. standards for computer security
and electronic commerce. He has addressed the U.S. Congress, by invitation, on
several topics, including digital signature standards, proposed FBI digital
telephony legislation, and global U.S. competitiveness. Mr. Fischer holds
numerous U.S. and international patents, and is a lifetime member of the
Association of Former Intelligence Officers.
MICHAEL S. BATTAGLIA has served as our President and Chief Executive
Officer since January 1998 and as a director since October 1998. From May 1995
to December 1998, Mr. Battaglia was President and Chief Executive Officer of
Fischer International Systems Corporation, a company controlled by Addison
Fischer, our Chairman of the board of directors and holder of a majority
interest in Phoenix House Investments, L.L.C., our major shareholder. During
1998, Mr. Battaglia served as an officer of
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both SmartDisk and Fischer International. From August 1992 to December 1994,
Mr. Battaglia was President of Mosler Inc., a provider of electronic security
systems and security equipment. For the 25-year period prior to his Mosler
tenure, Mr. Battaglia held various senior management positions in the computer
and information systems industry. He spent most of his professional career at
Sperry Corporation in New York City and Philadelphia. Mr. Battaglia also serves
on the board of directors of Fischer International, which is privately-held.
DOUGLAS R. KRAUL has served as our Vice President, Audio/Video Products
since July 1999. From February 1997 to June 1999, Mr. Kraul was President and
Chairman of Harmony Systems, Inc., a developer of Internet desktop client
software and applications for information management and electronic musical
products. From October 1993 until February 1997, Mr. Kraul served in several
positions with Motorola, Inc., an electronics and communications company, most
recently as Vice President, General Manager, Motorola Platform Software
Division and Vice President, General Manager, Personal Communicator Systems &
Software Division.
MICHAEL R. MATTINGLY has served as our Chief Financial Officer since May
1999 and was our Corporate Controller from February 1999 to May 1999.
Previously, Mr. Mattingly was employed by Mosler Inc., a provider of electronic
security systems and security equipment. During a 20-year career at Mosler, Mr.
Mattingly held various positions in finance and accounting, most recently Cost
Controller and Company Controller. Prior to his service with Mosler, Mr.
Mattingly served in various financial and accounting positions with American
Standard, Inc., a public company whose shares are traded on the New York Stock
Exchange. His professional background includes 28 years of general accounting,
cost accounting, planning and budgeting, as well as management of those
functions.
ROBERT PROTHEROE has served as our Senior Vice President, Research and
Development since March 1999. From November 1995 to March 1999, Mr. Protheroe
held senior management positions, most recently Vice President of Engineering,
at IVI/Checkmate Electronics, Inc., an Atlanta based designer and manufacturer
of point-of-sale payment systems. Prior to joining IVI/Checkmate, Mr. Protheroe
was employed by Electronic Power Technologies, Inc., AT&T Global Information
Systems and by NCR Corporation in various engineering and engineering
management positions.
DANIEL E. REED has served as our Vice President, Corporate Development and
Legal Affairs since May 1999. From August 1994 to May 1999, Mr. Reed was an
attorney with the law firm of Greenberg Traurig, P.A., Miami, Florida, where he
concentrated his law practice in the areas of mergers and acquisitions, public
offerings and private financings, representing both public and private
companies. From August 1989 to April 1991, Mr. Reed served as a senior auditor
with Ernst & Young, LLP, New York City, New York, concentrating his practice in
the financial services and electronics industries.
QURESH SACHEE has served as our Vice President, Marketing, since May 1998.
From 1993 to May 1998, Mr. Sachee was employed by IVI/Checkmate Electronics,
Inc., a designer and manufacturer of point-of-sale systems, in various
positions, including Executive Vice President, Senior Vice President of Product
Management, and prior to that, Vice President, International Sales. Prior to
that time, Mr. Sachee was employed by VeriFone, Inc., a Hewlett Packard
point-of-sale software products company, in various product development and
marketing management positions, and by Unisys Corporation.
YOSHIAKI UCHIDA has served as our Vice President and General Manager,
Asian Operations, since November 1998. Prior to that time, Mr. Uchida spent 33
years with Toshiba Corporation in various management positions. He served as
Deputy General Manager of Toshiba's OME manufacturing and development facility,
and most recently was Senior Executive Vice President of MediaServe
Corporation, a Toshiba affiliate.
D. JAMES BIDZOS has served as a director since May 1998. Mr. Bidzos is
presently Vice Chairman of the Board of Directors of Security Dynamics
Technologies, Inc., a network security company, and served as its Executive
Vice President from July 1996 to February 1999. From 1986 to February 1999,
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Mr. Bidzos served as President, Chief Executive Officer and a director of RSA
Data Security, Inc., an encryption software company that was acquired by
Security Dynamics Technologies in July 1996. Mr. Bidzos is Chairman of the
Board of Directors of VeriSign, Inc., an electronic credentials/digital
certificate company, and was Chief Executive Officer of that company from April
1995 to July 1995.
ANTHONY A. IBARGUEN has served as a director since August 1999. From
September 1996, Mr. Ibarguen has served in varying capacities at Tech Data
Corp., a manufacturer of micro-computer hardware and software, including
President and Chief Operating Officer since March 1997. Mr. Ibarguen also
serves as a director of Tech Data. From August 1993 to August 1996, he was
employed by ENTEX Information Services, Inc., an information technology
company, as Executive Vice President of Sales and Marketing.
SHIGEKI MORITA has served as a director since April 1999. Since 1994, Mr.
Morita has served in various capacities with Toshiba Corporation, including his
current position as General Manager, Strategic Marketing Divisions, which he
has held since November 1998.
TIMOTHY TOMLINSON has served as a director since SmartDisk's inception in
1997. He co-founded Tomlinson Zisko Morosoli & Maser LLP, a law firm, in 1983,
and has been a partner there since that time. Mr. Tomlinson also serves on the
board of directors of VeriSign, Inc., Oak Technology, Inc. and Portola
Packaging, Inc., as well as other, privately held companies, including Fischer
International where he has served since April 1999.
HATIM TYABJI has served as a director since August 1999. Since February
1999, Mr. Tyabji has been Chairman and Chief Executive Officer of Saraide,
Inc., a provider of Internet and wireless data services. From 1986 until 1998,
Mr. Tyabji served as President and Chief Executive Officer of VeriFone, Inc. He
also served as Chairman of VeriFone from 1992 until 1998. Mr. Tyabji is also a
director of Best Buy Co., Inc., PubliCARD, Inc., Deluxe Corporation, Ariba
Technologies, Inc., and Novatel Wireless, Inc.
JOSEPH M. TUCCI has served as a director since August 1999. Since August
1990, Mr. Tucci has been employed by Wang Laboratories, Inc., a provider of
information technology services and solutions, initially as Executive Vice
President, Operations, and, since January 1993, as President and Chief
Executive Officer. Mr. Tucci has been Chairman of the Board of Directors of
Wang Laboratories since October 1993. Mr. Tucci was appointed deputy Chief
Executive Officer and a director of Getronics NV, a provider of information and
communication technology services, when Wang Laboratories was acquired by
Getronics in June 1999. Wang Laboratories is currently a subsidiary of
Getronics.
O. LEE DRENNAN has served as our Director of Product Engineering since
January 1998. From March 1991 to January 1998, he served in a number of
positions for Fischer International and SmartDisk Security Corporation, most
recently as Director of Product Engineering for Fischer International.
KAZUHISA FUKATSU has served as Senior Manager, Production Control and
Assistant to the President of SmartDisk International since June 1998. From
July 1996 to May 1998, he served in the position of Director of Akia
Corporation, a computer and electronics company. From September 1992 to July
1996, he served as Controller for Serano Japan Co., Ltd., a pharmaceutical
company.
KAZUHIRO IWATA has served as Vice President, Engineering of SmartDisk
International since April 1999. Prior to that time, Mr. Iwata spent almost 28
years with Toshiba Corporation where he held a number of management positions,
most recently Chief Specialist, Engineering Administration.
JON KAPLAN has served as our Vice President, Software Development since
January 1998. Prior to that time, he spent 8 years with Fischer International
as Vice President, Product Development.
KONOSUKE NAKAMURA has served as Vice President, Marketing of SmartDisk
International since March 1999. Prior to that time, Mr. Nakamura spent nearly
29 years with Toshiba Corporation in
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<PAGE>
various management positions. Most recently, he served as a Senior Manager,
International Sales & Marketing, Storage Device Division for Toshiba.
BOARD OF DIRECTORS AND COMMITTEES
Our certificate of incorporation provides for a board of directors
consisting of three classes serving three-year staggered terms. Class I
consists of Michael S. Battaglia, Timothy Tomlinson and Joseph M. Tucci, with
the initial term of office of the Class I directors expiring at the annual
meeting of stockholders in 2000. Class II consists of Shigeki Morita and D.
James Bidzos, with the initial term of office of Class II directors expiring at
the annual meeting of stockholders in 2001. Class III consists of Addison M.
Fischer, Anthony A. Ibarguen and Hatim Tyabji, with the initial term of office
of Class III directors expiring at the annual meeting of stockholders in 2002.
The board of directors has a compensation committee and an audit
committee.
COMPENSATION COMMITTEE. The compensation committee of the board of
directors reviews and makes recommendations to the board regarding all forms of
compensation provided to the executive officers and directors of SmartDisk and
its subsidiaries including stock compensation and loans. In addition, the
compensation committee reviews and makes recommendations on stock compensation
arrangements for all employees of SmartDisk. The compensation committee also
administers our 1998 Employee Stock Option Plan, 1998 Directors and Consultants
Stock Option Plan, 1999 Incentive Compensation Plan and 1999 Employee Stock
Purchase Plan. The current members of the compensation committee are D. James
Bidzos, Hatim Tyabji and Joseph M. Tucci, with Mr. Bidzos chairing the
committee.
AUDIT COMMITTEE. The audit committee of the board of directors reviews and
monitors the corporate financial reporting and the internal and external audits
of SmartDisk, including, among other things, our internal audit and control
functions, the results and scope of the annual audit and other services
provided by our independent auditors and our compliance with legal requirements
that have a significant impact on our financial reports. The audit committee
also consults with our management and our independent auditors regarding the
preparation of financial statements and, as appropriate, initiates inquiries
into aspects of our financial affairs. In addition, the audit committee has the
responsibility to consider and recommend the appointment of, and to review fee
arrangements with, our independent auditors. The current members of the audit
committee are Timothy Tomlinson and Anthony A. Ibarguen, with Mr. Tomlinson
chairing the committee.
DIRECTOR COMPENSATION
Our 1999 Incentive Compensation Plan includes an automatic option grant
program for non-employee directors of SmartDisk. See "Employee Benefit Plans -
1999 Incentive Compensation Plan" for a description of the automatic grant
program.
Timothy Tomlinson, one of our directors, will receive a stock grant of
2,500 shares of our common stock upon completion of this offering.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The compensation committee of the board of directors consisted in 1998 of
Timothy Tomlinson and D. James Bidzos. It currently consists of Messrs. Bidzos,
Tyabji and Tucci. There were no compensation committee interlocks during our
last fiscal year.
EXECUTIVE COMPENSATION
The following table sets forth compensation information for the fiscal
year ended December 31, 1998 paid by us for services by our Chief Executive
Officer and our other executive officer whose total salary and bonus for that
fiscal year exceeded $100,000, collectively referred to below as the "named
executive officers":
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<PAGE>
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION AWARDS
------------------------------------ --------------------
SECURITIES ALL OTHER
NAME AND PRINCIPAL POSITION SALARY BONUS UNDERLYING OPTIONS COMPENSATION
- --------------------------------------- ----------------- ---------------- -------------------- -------------
<S> <C> <C> <C> <C>
Michael S. Battaglia .................. $ 100,440(1) $ 45,000(1) 426,136 --
Chief Executive Officer and President
Quresh Sachee ......................... 89,306 47,500 50,000 --
Vice President, Marketing
</TABLE>
- --------
(1) In addition, Mr. Battaglia received $100,440 in salary and $60,000 in bonus
from Fischer International for services rendered to Fischer International
in 1998. Commencing January 1, 1999, Mr. Battaglia became our full-time
employee.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth each grant of stock options during the
fiscal year ended December 31, 1998 to each of the named executive officers. No
stock appreciation rights were granted to these individuals during that year.
<TABLE>
<CAPTION>
OPTION GRANTS IN 1998
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
-------------------------------------------------------------- ANNUAL RATES OF
NUMBER OF % OF TOTAL STOCK PRICE APPRECIATION
SECURITIES OPTIONS GRANTED EXERCISE OR FOR OPTION TERM(1)
UNDERLYING TO EMPLOYEES BASE PRICE EXPIRATION ----------------------------
NAME OPTIONS GRANTED(2) IN FISCAL YEAR ($)(SH)(3) DATE 5%($) 10%($)
- ------------------------------ -------------------- ----------------- ------------ ----------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Michael S. Battaglia ......... 426,136 45.5% $ 0.72 1/27/08 $8,717,464 $14,063,340
Quresh Sachee ................ 30,000 3.2 1.00 5/4/08 605,310 981,660
20,000 2.1 4.00 8/21/08 343,540 594,440
</TABLE>
- --------
(1) Potential realizable value is based on the assumption that the common stock
price appreciates at the annual rate shown, compounded annually, from the
date of grant until the end of the option term. The amounts have been
calculated based on the assumed appreciation rates shown in the table,
assuming a per share market price at the time of grant of $13.00, which is
the initial public offering price. The actual value, if any, a named
executive officer may realize will depend on the excess of the stock price
over the exercise price on the date the option is exercised, if the
executive were to sell the shares on the date of exercise, so there is no
assurance that the value realized will be equal to or near the potential
realizable value as calculated in this table.
(2) The options granted to Michael Battaglia are immediately exercisable,
subject to our right to repurchase the shares upon the termination of Mr.
Battaglia's employment with us. Our repurchase right lapses as to 2% of
the shares each month for fifty months from the date of grant. The options
granted to Quresh Sachee in May 1998 are immediately exercisable, subject
to our repurchase right which lapses as to 25% of the shares one year
after the date of grant and as to 6.25% of the shares each quarter
thereafter. Those options granted to Mr. Sachee in August 1998 are
immediately exercisable, subject to our right of repurchase which lapses
as to 25% of the shares on January 1, 2000 and as to 6.25% of the shares
each quarter thereafter. Each of the options granted have a term of ten
years from the date of grant, subject to acceleration upon a change of
control of our company.
(3) Prior to this offering, there has been no public market for our common
stock. The exercise price of each of these options is equal to the fair
market value of our common stock on the date of grant as determined by our
board of directors.
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<PAGE>
AGGREGATE OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION
VALUES
The following table sets forth information concerning the year-end number
and value of unexercised options for each of the named executive officers.
There was no public trading market for the common stock as of December 31,
1998. In light of the substantial disparity between the fair market value of
the common stock as of December 31, 1998, and the initial public offering price
of the common stock, in order to quantify the effect of this offering on the
value of the options we have used $13.00, the initial public offering price, in
calculating the values in the table. These values have been calculated based on
a price of $13.00 per share, minus the applicable per share exercise price. We
have never granted stock appreciation rights. Value Realized is calculated by
subtracting the aggregate exercise price paid from the likely value of the
shares on completion of this offering.
AGGREGATE OPTION EXERCISES IN 1998 AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS
SHARES DECEMBER 31, 1998(#) AT DECEMBER 31, 1998($)
ACQUIRED VALUE ----------------------------- ----------------------------
NAME ON EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------ ---------------- ------------ ------------- --------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Michael S. Battaglia ......... 426,136 $5,232,950 -- -- -- --
Quresh Sachee ................ 30,000 360,000 20,000 -- $180,000 --
</TABLE>
EMPLOYMENT AGREEMENTS
The following executive officers have signed employment agreements with
SmartDisk.
MICHAEL S. BATTAGLIA. Mr. Battaglia's employment agreement has a
three-year term ending December 31, 2002. His annual base salary is $275,000
and he is eligible for annual merit increases at the discretion of our board of
directors and an annual bonus of $125,000 for 1999 if we achieve specific
revenue and profitability goals. Bonuses for the remaining years in the term
are at the discretion of the compensation committee of our board of directors.
If we terminate Mr. Battaglia without cause, we must pay him severance of six
months' base salary plus fifty percent of his bonus, if any, for the year in
which he was terminated. Mr. Battaglia has agreed not to compete with us for
one year after his employment if he resigns and for six months after his
employment if we terminate him.
ROBERT PROTHEROE. Mr. Protheroe's employment agreement has a three-year
term ending March 15, 2002. His annual base salary is $180,000 and he is
eligible for a bonus of $60,000 for 1999 if we achieve specific revenue and
profitability goals. We have agreed to reimburse Mr. Protheroe for up to
$40,000 in relocation expenses. Bonuses for the remaining years are at the
discretion of the compensation committee of our board of directors. If we
terminate Mr. Protheroe without cause, we must pay him severance of six months'
base salary. Mr. Protheroe has agreed not to compete with us for one year after
termination of his employment.
QURESH SACHEE. Mr. Sachee's employment agreement has a two-year term
ending May 3, 2000. His annual base salary is $150,000 and he is eligible for a
bonus of $50,000 for 1999 if we achieve specific revenue and profitability
goals. We agreed to reimburse Mr. Sachee for up to $40,000 in relocation
expenses. If we terminate Mr. Sachee without cause, we must pay him severance
of three months' base salary. Mr. Sachee has agreed not to compete with us for
one year after termination of his employment if he resigns and for six months
after his employment if we terminate him.
EMPLOYEE BENEFIT PLANS
1999 INCENTIVE COMPENSATION PLAN. Our board of directors adopted our 1999
Incentive Compensation Plan in July 1999 and our stockholders approved the
adoption of the plan in July 1999. We have reserved 2,500,000 shares of common
stock for issuance under the plan, of which options to purchase 73,500 shares
were outstanding as of August 31, 1999. Under the plan, officers, employees,
46
<PAGE>
members of the board of directors and consultants are eligible to receive
awards. The types of awards that may be made under the plan are options to
purchase shares of common stock, stock appreciation rights, restricted shares,
deferred shares, bonus shares, dividend equivalents and other stock-based
awards. Options may be either incentive stock options that qualify for
favorable tax treatment for the optionee under Section 422 of the Internal
Revenue Code of 1986 or nonstatutory stock options not designed to qualify for
favorable tax treatment. If shares awarded under the plan are forfeited, then
those shares will again become available for new awards under the plan. Annual
cash awards are limited to $10,000,000 per person, and annual cash performance
awards are limited to $20,000,000 per person.
The compensation committee of our board of directors administers the plan.
The committee has complete discretion to make all decisions relating to the
interpretation and operation of the plan, including the discretion to determine
which eligible individuals are to receive any award, and to determine the type,
number, vesting requirements and other features and conditions of each award.
The exercise price for incentive stock options granted under the plan may
not be less than 100% of the fair market value of the common stock on the
option grant date. The exercise price may be paid in cash or by other means,
including a cashless exercise method as determined by the committee.
The plan includes an automatic grant program for our non-employee
directors. Under the plan, non-employee directors are automatically granted
options to purchase 15,000 shares of common stock upon their initial election
to the board of directors and 500 shares upon appointment to any committee of
the board and upon appointment as chairman of a committee. Thereafter, the
directors are granted options to purchase an additional 6,000 shares in January
of each year that they serve on the board and 500 each year that they serve as
a member, and 500 each year that they serve as chairman, of a committee. All
options granted under the automatic grant program vest 2% a month for each
month after the grant. Directors who were serving on the board on the date that
the plan was adopted are eligible to participate in the program in 2001.
Otherwise, directors are eligible upon election.
Our board of directors may amend or terminate our plan at any time. If the
board amends the plan, stockholder approval of the amendment will be sought
only if required by an applicable law. The plan will continue in effect
indefinitely unless the board decides to terminate the plan earlier.
1999 EMPLOYEE STOCK PURCHASE PLAN. Our board of directors adopted our 1999
Employee Stock Purchase Plan in July 1999, and our stockholders approved the
adoption of the plan in July 1999. We have reserved 465,000 shares of common
stock for issuance under the plan, none of which has been issued. Once an
employee enters the plan, on the first day of each offering period he or she is
granted an option to purchase shares of our common stock, up to a maximum of
1,000 shares, on June 30 and December 31 of each offering period. The plan,
which is intended to qualify under Section 423 of the Internal Revenue Code of
1986, will be implemented through successive twelve-month offering periods,
generally commencing the first of January each year. The initial offering
period will commence on the effective date of this offering and will run
through December 31, 1999. The plan will be administered by the compensation
committee. Employees will be eligible to participate if they are employed by us
for at least 20 hours per week and have been employed for more than five (5)
months in a calendar year. The plan permits eligible employees to purchase
common stock through payroll deductions, which may not exceed 15% of an
employee's compensation. The price of stock purchased under the plan will be
85% of the lower of the fair market value of the common stock at the beginning
or the end of each twelve-month offering period. Employees may not be granted
shares under the plan if immediately following a grant they would hold stock
and/or options to acquire stock possessing more than 5% of the total voting
power of the shares of our company. In addition, employees may be granted
options to purchase a maximum of $25,000 worth of stock per year under the
plan. Employees may end their participation at any time and participation ends
automatically upon termination of employment with us. Our board of directors
may amend or terminate the plan at any time. If the board amends the plan,
stockholder approval of the amendment will be sought only if required by an
applicable law.
47
<PAGE>
1998 EMPLOYEE STOCK OPTION PLAN. Our board of directors adopted our 1998
Employee Stock Option Plan in January 1998, and our stockholders approved the
adoption of the plan in March 1998. We have reserved 1,454,545 shares of common
stock for issuance under the plan, of which options to purchase 821,969 shares
were outstanding as of August 31, 1999. Under the plan, the eligible
individuals are our employees or those of any parent or subsidiary. The types
of awards that may be made under the plan are options to purchase shares of
common stock. Options may be incentive stock options that qualify for favorable
tax treatment for the optionee under Section 422 of the Internal Revenue Code
of 1986 or nonstatutory stock options not designed to qualify for favorable tax
treatment. If options awarded under the plan are forfeited, then the shares
underlying those options will generally become available for new awards under
the plan.
Our board of directors or a committee of our board administers the plan.
The administrator has complete discretion to make all decisions relating to the
interpretation and operation of the plan, including the discretion to determine
which eligible individuals are to receive any award, and to determine the type,
number, vesting requirements and other features and conditions of each award.
The exercise price for incentive stock options granted under the plan may
not be less than 100% of the fair market value of the common stock on the
option grant date. The exercise price may be paid in cash or, at the discretion
of the compensation committee, in outstanding shares of common stock, by
delivery of a promissory note, or by any combination of cash, shares of common
stock or promissory notes. At the discretion of the compensation committee, the
exercise price may also be paid by using a cashless exercise method.
If a merger or other reorganization occurs, and our stockholders before
the transaction hold a majority of the voting securities of the acquiring or
surviving corporation after the transaction, outstanding options under the plan
shall become exercisable for securities of the acquiring or surviving
corporation. If our stockholders before the transaction hold less than a
majority of the voting securities of the acquiring or surviving corporation
after the transaction, outstanding options shall generally be canceled unless
the merger or reorganization agreement provides otherwise.
Our 1998 Employee Stock Option Plan was terminated in July 1999.
1998 DIRECTORS AND CONSULTANTS STOCK OPTION PLAN. Our board of directors
adopted our 1998 Directors and Consultants Stock Option Plan in January 1998,
and our stockholders approved the adoption of the plan in March 1998. We have
reserved 250,000 shares of common stock for issuance under the plan, of which
options to purchase 144,281 shares were outstanding as of August 31, 1999.
Under the plan, our officers, directors and consultants and those of our
subsidiaries are eligible for option grants and other awards. The types of
awards that may be made under the plan are options to purchase shares of common
stock. Options will be nonstatutory stock options and are not designed to
qualify for favorable tax treatment under Section 422 of the Internal Revenue
Code of 1986. If options awarded under the plan are forfeited, then the shares
underlying those options generally become available for new awards under the
plan
Our board of directors or a committee of the board administers the plan.
The administrator has complete discretion to make all decisions relating to the
interpretation and operation of the plan, including the discretion to determine
which eligible individuals are to receive any award, and to determine the type,
number, vesting requirements and other features and conditions of each award.
The exercise price for stock options granted under the plan shall be
determined by the compensation committee at the time of grant. The exercise
price may be paid in cash or, at the discretion of the committee, in
outstanding shares of common stock, by delivery of a promissory note, or by any
combination of cash, shares of common stock or promissory notes. At the
discretion of the committee, the exercise price may also be paid by using a
cashless exercise method.
If a merger or other reorganization occurs, and our stockholders before
the transaction hold a majority of the voting securities of the acquiring or
surviving corporation after the transaction,
48
<PAGE>
outstanding options under the plan shall become exercisable for securities of
the acquiring or surviving corporation. If our stockholders before the
transaction hold less than a majority of the voting securities of the acquiring
or surviving corporation after the transaction, outstanding options shall
generally be canceled unless the merger or reorganization agreement provides
otherwise.
Our 1998 Directors and Consultants Stock Option Plan was terminated in
July 1999.
49
<PAGE>
CERTAIN TRANSACTIONS
PRE-FORMATION ADVANCES
Prior to 1997, Addison Fischer and his affiliates, including Fischer
International, advanced SDSC, SmartDisk's predecessor, non-interest bearing
loans in the aggregate amount of approximately $9.6 million in order to fund
SmartDisk's operations. Of the total amount advanced to SDSC, approximately
$4.6 million was contributed to the capital stock of SDSC in 1996 and 1997.
SDSC repaid the remaining $5.0 million of advances in May 1998, of which
$1,045,000 was paid to Fischer International and $3,955,000 was paid to Addison
Fischer.
In addition, from 1996 to March 1999, Addison Fischer and his affiliates,
including Fischer International, advanced SmartDiskette Limited, or SDL,
non-interest bearing loans in the aggregate amount of approximately $600,000.
In May 1999, prior to SmartDisk's acquisition of SDL, these advances were
converted into 96,710 shares of SDL common stock and, after the acquisition in
May 1999, these shares were in turn converted into 76,018 shares of SmartDisk
common stock.
FORMATION TRANSACTIONS
Although SmartDisk commenced operations in January 1998, it did not
receive significant capital contributions until February of that year. In
February 1998, Toshiba, Phoenix House and SmartDisk entered into a joint
venture agreement which detailed a plan of capital contribution, corporate
governance and business strategies for SmartDisk. Pursuant to this agreement,
each of Toshiba, Fischer International and Phoenix House agreed to purchase
shares of SmartDisk common stock and become SmartDisk's principal stockholders.
Before the May 1998 stock purchases described below, all oustanding shares of
SmartDisk were owned by employees of, or consultants to, SmartDisk, as a result
of the exercise of stock options. None of SmartDisk's current directors,
executive officers or significant shareholders owned any shares before the
purchases described below.
The joint venture agreement called for Toshiba to make an immediate loan
to SmartDisk of $5.0 million in exchange for a convertible note. The note had
an interest rate of 4% per annum. The note remained outstanding until May 22,
1998. At that time, Toshiba acquired 2,487,500 shares of SmartDisk common stock
in exchange for a cash payment of $4,950,000 and delivery and cancellation of
the February 1998 note, including accrued interest.
At the same time that Toshiba purchased its shares of SmartDisk common
stock, both Phoenix House and Fischer International acquired shares of
SmartDisk common stock. Both Phoenix House and Fischer International are
controlled by Addison Fischer, the Chairman of SmartDisk's board of directors.
Phoenix House acquired 7,350,000 shares of SmartDisk common Stock in exchange
for all of the outstanding shares of SDSC. As a result, SDSC became a wholly
owned subsidiary of SmartDisk and SmartDisk became the owner of the exclusive
patent licenses owned by SDSC. Fischer International acquired 150,000 shares of
SmartDisk common stock in return for trademarks it owned relating to the
SafeBoot, FlashPath and Smarty products. Immediately after their capital
contributions, Phoenix House, Toshiba and Fischer International owned 68.8%,
23.3% and 1.4% of SmartDisk's outstanding common stock.
On May 26, 1999, the shareholders of SDL, which included Addison Fischer
and Phoenix House, exchanged all of their shares of SDL for 515,500 shares of
SmartDisk common stock. Of the total number of SmartDisk shares issued, Addison
Fischer received 428,768 shares, Phoenix House received 32,918 shares and the
other shareholders of SDL received the remaining 53,814 shares. As a result of
this transaction, SmartDisk acquired 100% of SDL, the indirect owner of its
current principal patents.
FISCHER TRANSACTIONS
In 1996 and 1997, all of the products of SDSC were sold through Fischer
International and its affiliates. Under this arrangement, Fischer International
and its affiliates received a fee of
50
<PAGE>
approximately 25% of the sales of SDSC. The consolidated revenues shown in
SmartDisk's 1996 and 1997 financial statements, which reflect the revenue of
SDSC, are net of the fees paid to Fischer International and its affiliates. In
addition, operating expenses totaling approximately $2.3 million in 1996 and
$4.0 million in 1997 were incurred by Fischer International on behalf of SDSC.
In January 1998, SDSC entered into an operating agreement with Fischer
International and SmartDisk to provide operating services to SDSC, including
developing and marketing the SafeBoot, FlashPath and Smarty products. SDSC
agreed in return to reimburse Fischer International and SmartDisk for the
expenses related to providing those services. Upon SmartDisk's obtaining
control of SDSC in May 1998, this agreement was terminated and replaced with a
new operating agreement between Fischer International and SmartDisk. Under this
new agreement, as amended in June 1999, SmartDisk reimburses Fischer
International for marketing, accounting and other similar services. In
addition, until recently SmartDisk has shared office space with Fischer
International. SmartDisk has reimbursed Fischer International for the cost of
this office space as well as other general and administrative expenses.
SmartDisk's share of these expenses is based on an internal analysis of the
relative amount of time devoted to its business by employees of Fischer
International as well as the overhead charges attributable to these employees.
In 1998, SmartDisk paid Fischer International $1.5 million under this
arrangement for the reimbursement of expenses under the operating agreement and
for the other shared services.
In May 1998, SmartDisk entered into license and distribution agreements
with Fischer International. Under these agreements, SmartDisk granted Fischer
International a non-exclusive license to its SafeBoot product and distribution
rights to its SafeBoot, Smarty and FlashPath products until 2001. Pursuant to
this agreement, Fischer International agreed to pay SmartDisk 33.3% of the net
revenue derived from the sale of SmartDisk products on a stand-alone basis and
5% of the net revenue derived from the sale of SmartDisk products which are
bundled with the products of third parties. In 1998, SmartDisk received
approximately $285,000 from Fischer International under these agreements in
royalties related to SafeBoot, and no royalties related to Smarty and
FlashPath.
TOSHIBA TRANSACTIONS
In May 1998, SmartDisk entered into a license agreement with Toshiba,
which was contemporaneously becoming one of our principal shareholders. Under
this agreement, Toshiba granted us a non-exclusive license to patents relating
to the interface with Toshiba's SmartMedia cards. We agreed to pay a one-half
of 1% royalty on the net sales price of our products that use the Toshiba
license. This agreement was amended in September 1998 to expand the field of
use for the non-exclusive license. In 1998, we paid approximately $69,000 to
Toshiba under this license.
In addition, we sell a number of our products to an affiliate of Toshiba
which in turn serves as sales agent to Toshiba in its role as an OEM customer.
In 1997 and 1998, we had aggregate sales to Toshiba or the sales agent of
approximately $495,000 and $0.
Also, since September 1998, four engineers from Toshiba have worked for us
on a contract basis. In 1998, we paid Toshiba $74,296 for these services.
EMPLOYEE ADVANCES
On March 3, 1998, we loaned Michael Battaglia $305,114 in connection with
Mr. Battaglia's exercise of an option to acquire 426,136 shares of common
stock. The loan bears interest at the rate of 5.47% per year and the interest
is payable quarterly. The principal balance is due on the earlier of March 3,
2003 or the end of his employment with us or an affiliate of ours.
On March 3, 1998, we loaned David Stone, a former officer, $61,023 in
connection with Mr. Stone's exercise of an option to acquire 85,227 shares of
common stock. The loan bore interest at the rate of 5.47% per year and was
repaid in full in June 1998.
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<PAGE>
On March 29, 1999, we loaned Robert Protheroe $60,000 in connection with
his repayment of amounts owed to his previous employer. The loan bears interest
at the rate of 4.71% per year and is due in four annual installments ending in
2003, unless his employment with us ends at an earlier date, in which case the
principal balance and accrued interest are due within 30 days after termination
of employment.
OTHER TRANSACTIONS
On May 28, 1998, we sold 28,750 shares of our common stock at a price of
$4.00 per share to First TZMM Investment Partnership, an entity affiliated with
Tomlinson Zisko Morosoli & Maser LLP. Timothy Tomlinson, one of our directors,
is a partner of Tomlinson Zisko Morosoli & Maser LLP.
On July 1, 1999, as part of a larger round of investments led by SCM
Microsystems, we sold an aggregate of 20,000 shares of common stock to Messrs.
Tomlinson and Bidzos, two of our directors, for $160,000, or $8.00 per share.
Individually, Mr. Tomlinson received 7,500 shares and Mr. Bidzos received
12,500 shares. In addition, First TZMM Investment Partnership acquired 27,500
shares for $220,000.
Timothy Tomlinson, one of our directors, is a partner of Tomlinson Zisko
Morosoli & Maser LLP, which provided legal services to us in 1998. Fees paid in
1998 to Mr. Tomlinson's firm did not exceed 5% of the law firm's gross revenues
for its last full fiscal year.
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PRINCIPAL STOCKHOLDERS
The table below sets forth information regarding the beneficial ownership
of SmartDisk's common stock as of August 31, 1999, by the following individuals
or groups:
/bullet/ Each person or entity who is known by SmartDisk to own
beneficially more than 5.0% of SmartDisk's outstanding stock;
/bullet/ Each of the named executive officers;
/bullet/ Each director of SmartDisk; and
/bullet/ All directors and executive officers as a group.
Unless otherwise indicated, the address of each of the individuals listed
in the table is c/o SmartDisk Corporation, 3506 Mercantile Avenue, Naples,
Florida 34104. Except as otherwise indicated, the persons named in the table
have sole voting and investment power with respect to all shares of common
stock held by them.
Percentage ownership in the following table is based on 12,523,511 shares
of common stock outstanding as of August 31, 1999. Beneficial ownership is
determined in accordance with the rules of the Securities and Exchange
Commission and generally includes voting or investment power with respect to
securities. Shares of our common stock subject to options that are presently
exercisable or exercisable within 60 days of August 31, 1999 are deemed to be
outstanding and beneficially owned by the person holding the options for the
purpose of computing the percentage of ownership of that person, but are not
treated as outstanding for the purpose of computing the percentage of any other
person.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED
AS A PERCENTAGE OF CLASS OUTSTANDING
NUMBER OF SHARES ------------------------------------
NAME OF BENEFICIAL OWNER BENEFICIALLY OWNED BEFORE OFFERING AFTER OFFERING
- ---------------------------------------------- ------------------- ----------------- ---------------
<S> <C> <C> <C>
Phoenix House Investments, L.L.C.(1) ......... 7,382,917 59.0% 47.6%
Addison M. Fischer(2) ........................ 7,961,685 63.6 51.3
Toshiba Corporation(3) ....................... 2,487,500 19.9 16.0
Michael S. Battaglia ......................... 410,136 3.3 2.6
Quresh Sachee(4) ............................. 50,000 * *
D. James Bidzos(5) ........................... 31,250 * *
Timothy Tomlinson(6) ......................... 21,584 * *
Anthony A. Ibarguen(7) ....................... 620 * *
Hatim Tyabji(8) .............................. 620 * *
Joseph M. Tucci(9) ........................... 620 * *
Shigeki Morita ............................... 0 0 0
All directors and executive officers
as a group (14 persons)(10) ................ 8,476,515 67.6 54.5
</TABLE>
- --------
* Less than one percent.
(1) The address for Phoenix House is 400 West King Street, Carson City, Nevada
89703. Phoenix House is controlled by Addison M. Fischer, the Chairman of
our board of directors.
(2) Includes 7,382,917 shares held of record by Phoenix House and 150,000
shares held by Fischer International. Mr. Fischer effectively controls
both entities.
(3) The address for Toshiba Corporation is 1-1 Shibaura 1-Chome, Minato-ku,
Tokyo 105, Japan.
(4) Includes 20,000 shares subject to options either currently exercisable or
exercisable by Mr. Sachee within 60 days of August 31, 1999.
(5) Excludes shares held by Phoenix House, in which Mr. Bidzos owns a 2.5%
ownership interest. Mr. Bidzos disclaims beneficial ownership of the
shares held by Phoenix House.
53
<PAGE>
(6) Includes 1,500 shares held by trusts for which Mr. Tomlinson is the sole
trustee. Mr. Tomlinson disclaims beneficial ownership of those shares.
Also includes 7,417 shares held by an investment fund as to which Mr.
Tomlinson exercises sole voting and dispositive power.
(7) Includes 620 shares subject to options either currently exercisable or
exercisable by Mr. Ibarguen within 60 days of August 31, 1999.
(8) Includes 620 shares subject to options either currently exercisable or
exercisable by Mr. Tyabji within 60 days of August 31, 1999.
(9) Includes 620 shares subject to options either currently exercisable or
exercisable by Mr. Tucci within 60 days of August 31, 1999.
(10) See footnotes (2), (4), (5), (6), (7), (8) and (9) above.
54
<PAGE>
DESCRIPTION OF CAPITAL STOCK
GENERAL
Our authorized capital stock consists of 60,000,000 shares of common
stock, $0.001 par value, and 5,000,000 shares of preferred stock, $0.001 par
value.
COMMON STOCK
As of August 31, 1999, there were 12,523,511 shares of common stock
outstanding that were held of record by approximately 43 stockholders. There
will be 15,523,511 shares of common stock outstanding, assuming no exercise
after August 31, 1999 of outstanding options, after giving effect to the sale
of the shares of common stock offered to the public by this prospectus.
The holders of common stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to any preferential
rights of preferred stock holders, the holders of common stock are entitled to
receive dividends on a pro rata basis, if any, declared from time to time by
the board of directors out of legally available funds. We have never paid
dividends in the past and do not intend to do so in the future. In the event of
our liquidation, dissolution or winding up, subject to any preferential rights
of preferred stock holders, the holders of common stock are entitled to share
on a pro rata basis in all assets remaining after payment of liabilities. The
common stock has no preemptive or conversion rights or other subscription
rights. There are no redemption or sinking fund provisions applicable to the
common stock. All outstanding shares of common stock are fully paid and
nonassessable, and the shares of common stock to be issued upon completion of
this offering will be fully paid and nonassessable.
PREFERRED STOCK
On the closing of this offering, no shares of preferred stock will be
outstanding. The board of directors has the authority to issue the preferred
stock in one or more series and to fix the rights, preferences, privileges and
restrictions of the preferred stock, including dividend rights, dividend rates,
conversion rights, voting rights, terms of redemption, redemption prices,
liquidation preferences and the number of shares constituting any series or the
designation of any series, without further vote or action by the stockholders.
The issuance of preferred stock may have the effect of delaying, deferring or
preventing a change in control of our company without further action by the
stockholders and may adversely affect the voting and other rights of the
holders of common stock. The issuance of preferred stock with voting and
conversion rights may adversely affect the voting power of the holders of
common stock, including the loss of voting control to others. At present, we
have no plans to issue any preferred stock.
REGISTRATION RIGHTS
Concurrently with the purchase of our common stock by Toshiba Corporation,
Phoenix House Investments, L.L.C. and Fischer International Systems
Corporation, we entered into an agreement providing registration rights for
Toshiba, Phoenix House and Fischer International. At any time after 180 days
following the date of this prospectus, Toshiba Corporation, Phoenix House
Investments, L.L.C. or the holders of a majority of the shares held by them may
require us to file a registration statement under the Securities Act covering
at least 20% of the securities of SmartDisk held by them, or a lesser
percentage if the net aggregate offering price would exceed $10.0 million. We
will not be required to comply with a request for registration on more than
three occasions or within 60 days before or 180 days after our good faith
estimate of the effective date of another registration statement filed pursuant
to a request.
When we are eligible to utilize a registration statement on Form S-3 to
register an offering of our securities, holders of 20% of the shares held by
Toshiba Corporation, Phoenix House Investments,
55
<PAGE>
L.L.C. and Fischer International Systems Corporation may request that we file a
registration statement on Form S-3, covering all or a portion of securities of
SmartDisk held by them, provided that the aggregate public offering price is at
least $500,000. These holders can request only two S-3 registrations.
These registration rights will be subject to SmartDisk's right to delay
the filing of a registration statement if, in the view of our board of
directors, a filing would be seriously detrimental to us, not more than once in
any 12-month period, for not more than 150 days after the appropriate number of
holders have requested we file a registration statement.
In addition, Toshiba Corporation, Phoenix House Investments, L.L.C., SCM
Microsystems, Inc. and Fischer International Systems Corporation have
"piggyback" registration rights. If we propose to register any common stock
under the Securities Act, other than pursuant to the registration rights noted
above and in some other instances, Toshiba Corporation, Phoenix House
Investments, L.L.C. and Fischer International Systems Corporation may require
us to include all or a portion of their securities in the registration.
However, the managing underwriter, if any, of any offering has the right to
limit the number of securities proposed to be included in the registration.
We are required to bear all registration expenses incurred in connection
with these registrations. Toshiba Corporation, Phoenix House Investments,
L.L.C. and Fischer International Systems Corporation will pay all underwriting
discounts and selling commissions applicable to the sale of their securities.
We also agreed to indemnify Toshiba Corporation, Phoenix House
Investments, L.L.C. and Fischer International Systems Corporation for any
damages they suffer due to any untrue statement or omission that we make in a
registration statement covering their shares.
The registration rights of Toshiba Corporation, Phoenix House Investments,
L.L.C. and Fischer International Systems Corporation under the agreement
providing registration rights will terminate, as to each of them, when it may
sell all its shares in a three-month period under Rule 144 under the Securities
Act.
ANTITAKEOVER EFFECTS OF DELAWARE LAW AND PROVISIONS OF OUR CERTIFICATE OF
INCORPORATION AND BYLAWS
CERTIFICATE OF INCORPORATION AND BYLAWS. Our certificate of incorporation
provides that all stockholder actions must be effected at a duly called meeting
and not by a consent in writing. Our certificate of incorporation also provides
that the affirmative vote of 80% of our outstanding stock is required to remove
any of our directors, to approve a business combination involving our company
or for our stockholders to amend our bylaws or the anti-takeover provisions of
our certificate of incorporation. Our bylaws provide that our stockholders may
not call a special meeting of stockholders. The bylaws also include advance
notice procedures with regard to the nomination, other than by the board of
directors, of candidates for director elections. These provisions of our
certificate of incorporation and bylaws could discourage potential acquisition
proposals and could delay or prevent a change in control of SmartDisk. These
provisions are intended to enhance the likelihood of continuity and stability
in the composition of our board of directors and in the policies formulated by
our board of directors and to discourage some types of transactions that may
involve an actual or threatened change of control of SmartDisk. These
provisions are designed to reduce our vulnerability to an unsolicited
acquisition proposal. The provisions also are intended to discourage tactics
that may be used in proxy fights. However, these provisions could have the
effect of discouraging others from making tender offers for our shares or proxy
fights and, as a consequence, they also may inhibit fluctuations in the market
price of our shares that could result from actual or rumored takeover attempts.
These provisions also may have the effect of preventing changes in our
management.
DELAWARE ANTITAKEOVER LAW. SmartDisk is subject to Section 203 of the
Delaware General Corporation Law, an antitakeover law. In general, Section 203
prohibits a publicly held Delaware
56
<PAGE>
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years following the date the person became
an interested stockholder, unless the "business combination" or the transaction
in which the person became an interested stockholder is approved in a
prescribed manner. Generally, a "business combination" includes a merger, asset
or stock sale, or other transaction resulting in a financial benefit to the
interested stockholder. Generally, an "interested stockholder" is a person who,
together with affiliates and associates, owns or within three years prior to
the determination of interested stockholder status, did own, 15.0% or more of a
corporation's voting stock. The existence of this provision may have an
antitakeover effect with respect to transactions not approved in advance by the
board of directors, including discouraging attempts that might result in a
premium over the market price for the shares of common stock held by
stockholders.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the common stock is American Stock
Transfer & Trust Company.
57
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for the common stock of
SmartDisk, and there can be no assurance that a significant public market for
the common stock will develop or be sustained after this offering. Future sales
of substantial amounts of common stock, including shares issued upon exercise
of outstanding options, in the public market following this offering could
adversely affect market prices prevailing from time to time and could impair
our ability to raise capital through sale of our equity securities. As
described below, no shares currently outstanding will be available for sale
immediately after this offering because of contractual restrictions on resale.
Sales of substantial amounts of our common stock in the public market after the
restrictions lapse could adversely affect the prevailing market price and our
ability to raise equity capital in the future.
Upon completion of this offering, we will have outstanding 15,523,511
shares of common stock based upon shares outstanding as of August 31, 1999,
assuming no exercise of outstanding options prior to completion of this
offering and no exercise of the underwriters' over-allotment option. Of these
shares, the 3,000,000 shares sold in this offering will be freely tradable
without restriction under the Securities Act except for any shares purchased by
"affiliates" of SmartDisk as that term is defined in Rule 144 under the
Securities Act. The remaining 12,523,511 shares of common stock held by
existing stockholders are "restricted securities" as that term is defined in
Rule 144. All of these restricted shares are subject to lock-up agreements
providing that the stockholder generally will not offer, sell, contract to sell
or otherwise dispose of any common stock or any securities that are convertible
into common stock for a period of 180 days after the date of this prospectus
without the prior written consent of BancBoston Robertson Stephens Inc. As a
result of these lock-up agreements, notwithstanding possible earlier
eligibility for sale under the provisions of Rules 144, 144(k) and 701, none of
these shares will be eligible for resale until 181 days after the date of this
prospectus. BancBoston Robertson Stephens Inc. may, at its sole discretion, and
at any time without notice, release all or any portion of the securities
subject to lock-up agreements.
Beginning 181 days after the date of this prospectus, approximately 12.5
million restricted shares will be eligible for sale in the public market, all
of which are subject to the volume limitations under Rule 144 described below.
In general, the volume limitations under Rule 144, as currently in effect,
provide that beginning 90 days after the date of this prospectus, a person who
has beneficially owned restricted shares for at least one year, including the
holding period of any prior owner except an affiliate, would be entitled to
sell in any three-month period a number of shares that does not exceed the
greater of:
/bullet/ 1.0% of the number of shares of our common stock then outstanding,
which will equal approximately 155,235 shares immediately after
this offering; or
/bullet/ the average weekly trading volume of our common stock during the
four calendar weeks preceding the filing of Form 144 with respect
to the sale.
Sales under Rule 144 must also be made in broker's transactions and are
subject to notice requirements and to the public availability of current
information about SmartDisk.
Within 90 days following the effectiveness of this offering, we will file
a registration statement on Form S-8 registering shares of common stock subject
to outstanding options or reserved for future issuance under its stock option
plans. As of August 31, 1999, options to purchase a total of 821,969 shares
were outstanding and no shares were reserved for future issuance under our 1998
Employee Stock Option Plan, options to purchase a total of 144,281 shares were
outstanding and no shares were reserved for future issuance under the 1998
Directors and Consultants Stock Option Plan, options to purchase a total of
73,500 shares were outstanding and 2,426,500 shares were reserved for future
issuance under the 1999 Incentive Compensation Plan, and 465,000 shares were
reserved for issuance under the 1999 Employee Stock Purchase Plan. The holders
of all of those outstanding options are
58
<PAGE>
subject to lock-up agreements. Common stock issued upon exercise of outstanding
vested options, other than common stock issued to our affiliates, will be
available for resale in the open market 181 days after the close of this
offering.
Beginning six months after the date of this offering, Toshiba Corporation,
Phoenix House Investments, L.L.C. and Fischer International Systems Corporation
will be entitled to registration rights for sale of their shares in the public
market. Registration of those shares under the Securities Act would result in
those shares becoming freely tradable without restriction under the Securities
Act, except for shares purchased by affiliates, immediately upon the
effectiveness of the registration and this could affect the stock price at that
time.
59
<PAGE>
UNDERWRITING
The underwriters named below, acting through their representatives,
BancBoston Robertson Stephens Inc., Hambrecht & Quist LLC and U.S. Bancorp
Piper Jaffray Inc., have severally agreed with SmartDisk, subject to the terms
and conditions set forth in the underwriting agreement, to purchase from
SmartDisk the number of shares of common stock set forth opposite their names
below. The underwriters are committed to purchase and pay for all the shares if
any are purchased.
<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
- --------------------------------------------------- ------------
<S> <C>
BancBoston Robertson Stephens Inc. ......... 1,300,000
Hambrecht & Quist LLC ...................... 780,000
U.S. Bancorp Piper Jaffray Inc. ............ 520,000
E*TRADE Securities ......................... 100,000
First Security Van Kasper .................. 100,000
First Union Securities, Inc. ............... 100,000
Suretrade .................................. 100,000
---------
Total .................................... 3,000,000
=========
</TABLE>
SmartDisk has been advised by the representatives of the underwriters that
the underwriters propose to offer the shares of common stock to the public at
the initial public offering price set forth on the cover page of this
prospectus and to some dealers at that price less a concession of not in excess
of $0.55 per share, of which $0.10 may be reallowed to other dealers. After the
initial public offering, the public offering price, concession and reallowance
to dealers may be reduced by the representatives. No reduction shall change the
amount of proceeds to be received by SmartDisk as set forth on the cover page
of this prospectus. The common stock is offered by the underwriters, subject to
receipt and acceptance by them and subject to their right to reject any order
in whole or in part.
The underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
OVER-ALLOTMENT OPTION. SmartDisk has granted to the underwriters an
option, exercisable during the 30-day period after the date of this prospectus,
to purchase up to 450,000 additional shares of common stock at the same price
per share as SmartDisk will receive for the 3,000,000 shares that the
underwriters have agreed to purchase. To the extent that the underwriters
exercise this option, each of the underwriters will have a firm commitment to
purchase approximately the same percentage of additional shares that the number
of shares of common stock to be purchased by it shown in the above table
represents as a percentage of the shares offered by this prospectus. If
purchased, the additional shares will be sold by the underwriters on the same
terms as those on which the 3,000,000 shares are being sold. SmartDisk will be
obligated, pursuant to the option, to sell shares to the extent the option is
exercised. The underwriters may exercise the option only to cover
over-allotments made in connection with the sale of the shares of common stock
offered by this prospectus. If the option is exercised in full, the total
public offering price, underwriting discounts and commissions and proceeds to
SmartDisk will be $44,850,000, $3,139,500 and $41,710,500, respectively.
The following table summarizes the compensation and expenses we will pay.
<TABLE>
<CAPTION>
TOTAL
----------------------------------
WITHOUT WITH
PER SHARE OVER-ALLOTMENT OVER-ALLOTMENT
----------- ---------------- ---------------
<S> <C> <C> <C>
Underwriting discounts and commissions paid by us ......... $ 0.91 $2,730,000 $3,139,500
Expenses payable by us .................................... $ -- $1,290,000 $1,290,000
</TABLE>
INDEMNITY. The underwriting agreement contains covenants of indemnity
among the underwriters and SmartDisk against some civil liabilities, including
liabilities under the Securities Act and liabilities arising from breaches of
representations and warranties contained in the underwriting agreement.
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<PAGE>
LOCK-UP AGREEMENTS. Each of SmartDisk's executive officers, directors,
director-nominees, stock-holders of record and option-holders of record has
agreed with the representatives of the underwriters, for a period of 180 days
after the date of this prospectus, subject to some exceptions, not to offer to
sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant
any rights with respect to any shares of common stock, any options or warrants
to purchase any shares of common stock, or any securities convertible into or
exchangeable for shares of common stock owned as of the date of this prospectus
or thereafter acquired directly by the holders or with respect to which they
have or hereafter acquire the power of disposition, without the prior written
consent of BancBoston Robertson Stephens Inc. However, BancBoston Robertson
Stephens Inc. may, in its sole discretion and at any time without notice,
release all or any portion of the securities subject to the lock-up agreements.
There are no agreements between the representatives and any of SmartDisk's
stockholders providing consent by the representatives to the sale of shares
prior to the expiration of the lock-up period.
FUTURE SALES. In addition, SmartDisk has agreed that during the lock-up
period SmartDisk will not, without the consent of BancBoston Robertson Stephens
Inc., subject to some exceptions,
/bullet/ consent to the disposition of any shares held by stockholders
subject to lock-up agreements prior to the expiration of the
lock-up period or
/bullet/ issue, sell, contract to sell, or otherwise dispose of, any shares
of common stock, any options to purchase any shares of common stock
or any securities convertible into, exercisable for or exchangeable
for shares of common stock other than SmartDisk's sale of shares in
this offering, the issuance of common stock upon the exercise of
outstanding options, and the issuance of options or shares under
existing stock option and incentive plans provided those options do
not vest, or the right to resell those shares do not arise until,
prior to the expiration of the lock-up period.
LISTING. The common stock has been approved for quotation on the Nasdaq
National Market under the symbol "SMDK."
NO PRIOR PUBLIC MARKET. Prior to this offering, there has been no public
market for the common stock of SmartDisk. Consequently, the initial public
offering price for the common stock offered by this prospectus has been
determined through negotiations between SmartDisk and the representatives of
the underwriters. Among the factors considered in the negotiations were
prevailing market conditions, financial information of SmartDisk, market
valuations of other companies that SmartDisk and the representatives believe to
be comparable to SmartDisk, estimates of the business potential of SmartDisk,
the present state of SmartDisk's development and other factors deemed relevant.
STABILIZATION. The representatives of the underwriters have advised
SmartDisk that some persons participating in this offering may engage in
transactions, including stabilizing bids, syndicate covering transactions or
the imposition of penalty bids, that may have the effect of stabilizing or
maintaining the market price of the common stock at a level above that which
might otherwise prevail in the open market. A "stabilizing bid" is a bid for or
the purchase of the common stock on behalf of the underwriters for the purpose
of fixing or maintaining the price of the common stock. A "syndicate covering
transaction" is the bid for or the purchase of the common stock on behalf of
the underwriters to reduce a short position incurred by the underwriters in
connection with this offering. A "penalty bid" is an arrangement permitting the
representatives to reclaim the selling concession otherwise accruing to an
underwriter or syndicate member in connection with this offering, if the common
stock originally sold by the underwriter or syndicate member is purchased by
the representatives in a syndicate covering transaction and has therefore not
been effectively placed by the underwriter or syndicate member. The
representatives have advised SmartDisk that the transactions may be effected on
the Nasdaq National Market or otherwise and, if commenced, may be discontinued
at any time.
DIRECTED SHARE PROGRAM. At our request, the underwriters have reserved up
to 7.5 percent of the shares of common stock to be issued by SmartDisk and
offered by this prospectus for sale, at the
61
<PAGE>
initial public offering price, to directors, officers, employees, business
associates and related persons of SmartDisk. Those shares will be offered to
the program participants on the same basis as the shares offered to the general
public. The number of shares of common stock available for sale to the general
public will be reduced to the extent that those individuals purchase all or a
portion of these reserved shares. Any reserved shares which are not so
purchased will be offered by the underwriters to the general public on the same
basis as the shares of common stock offered by this prospectus.
LEGAL MATTERS
The validity of the common stock offered by this prospectus will be passed
upon for SmartDisk by Greenberg Traurig, P.A., Miami, Florida. Certain legal
matters in connection with the offering will be passed upon for the
underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation,
Palo Alto, California.
EXPERTS
Ernst & Young LLP, independent certified public accountants, have audited
our consolidated financial statements at December 31, 1997 and 1998 and June
30, 1999 and for each of the three years in the period ended December 31, 1998
and the six months ended June 30, 1999, as set forth in their report. We have
included our financial statements in this prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's report, given on
their authority as experts in accounting and auditing.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission, Washington,
D.C. 20549, a registration statement on Form S-1 under the Securities Act with
respect to the common stock offered by this prospectus. This prospectus does
not contain all of the information set forth in the registration statement and
the exhibits and schedules to the registration statement. For further
information with respect to SmartDisk and the common stock offered by this
prospectus, refer to the registration statement and the exhibits and schedules
filed as a part of the registration statement. Statements contained in this
prospectus concerning the contents of any contract or any other document
referred to are not necessarily complete; refer in each instance to the copy of
the contract or document filed as an exhibit to the registration statement.
Each statement of the type referred to in the preceding sentence is qualified
in all respects by reference to the exhibit. You may inspect a copy of the
registration statement without charge at the Securities and Exchange
Commission's principal office in Washington, D.C. and obtain copies of all or
any part thereof upon payment of a fee from the Public Reference Room of the
Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C.
20549, or at the Securities and Exchange Commission's regional offices in New
York, located at 7 World Trade Center, Suite 1300, New York, New York 10048, or
in Chicago, located at 500 West Madison Street, Suite 1400, Chicago, Illinois
60661. You may obtain information on the operation of the Public Reference Room
by calling the Securities and Exchange Commission at 1-800-SEC-0330. The
Securities and Exchange Commission maintains an Internet site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Securities and Exchange
Commission. The Securities and Exchange Commission's World Wide Web address is
www.sec.gov.
SmartDisk intends to furnish holders of its common stock with annual
reports containing, among other information, audited financial statements
certified by an independent public accounting firm and quarterly reports
containing unaudited condensed financial information for the first three
quarters of each fiscal year. SmartDisk intends to furnish other reports as it
may determine or as may be required by law.
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<PAGE>
SMARTDISK CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1997 and 1998 and
Six months ended June 30, 1998 (Unaudited) and 1999
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Independent Certified Public Accountants .................................... F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998 and June 30, 1999 ........ F-3
Consolidated Statements of Operations for the Years Ended December 31, 1996, 1997 and
1998 and for the Six Months Ended June 30, 1998 (Unaudited) and 1999 ................ F-4
Consolidated Statements of Stockholders' Deficit for the Years Ended December 31, 1996,
1997 and 1998 and for the Six Months Ended June 30, 1999 ............................ F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1997 and
1998 and for the Six Months Ended June 30, 1998 (Unaudited) and 1999 ................ F-6
Notes to Consolidated Financial Statements ............................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of SmartDisk Corporation:
We have audited the accompanying consolidated balance sheets of SmartDisk
Corporation as of December 31, 1997 and 1998, and June 30, 1999, and the
related consolidated statements of operations, stockholders' deficit and cash
flows for each of the three years in the period ended December 31, 1998 and for
the six months ended June 30, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of SmartDisk Corporation at December 31, 1997 and 1998, and June 30, 1999, and
the consolidated results of its operations and its cash flows for each of the
three years in the period ended December 31, 1998 and for the six months ended
June 30, 1999, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Miami, Florida,
August 11, 1999
F-2
<PAGE>
SMARTDISK CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
PRO FORMA
STOCKHOLDERS'
DECEMBER 31, EQUITY AT
-------------------------------- JUNE 30, JUNE 30,
1997 1998 1999 1999 (NOTE 7)
---------------- --------------- --------------- ----------------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents ............................. $ 329,778 $ 2,919,728 $ 1,335,145
Restricted cash ....................................... -- 1,050,000 1,050,000
Accounts receivable, net of allowance for doubtful
accounts of $0 in 1997, $33,848 in 1998 and
$70,814 in 1999 ..................................... -- 3,736,751 8,945,407
Inventories, net ...................................... 294,496 1,689,020 376,312
Prepaid expenses and other current assets ............. 24,005 120,782 880,672
------------- ------------- -------------
Total current assets ................................. 648,279 9,516,281 12,587,536
Property and equipment, net ............................ 210,119 682,014 1,956,298
Intangible assets, net ................................. 748,137 740,978 771,168
Deposits and other assets .............................. -- 196,682 123,657
------------- ------------- -------------
TOTAL ASSETS ........................................... $ 1,606,535 $ 11,135,955 $ 15,438,659
============= ============= =============
LIABILITIES, REDEEMABLE COMMON
STOCK, AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable ...................................... $ 253,812 $ 3,706,297 $ 4,646,017
Bank line of credit ................................... -- 2,247,718 4,455,088
Deferred research and development
contract revenue .................................... -- -- 968,415
Other accrued liabilities ............................. 147,933 693,590 1,392,815
Due to related parties ................................ 1,045,000 -- --
Stockholder loan ...................................... 3,955,000 -- --
------------- ------------- -------------
Total current liabilities ............................ 5,401,745 6,647,605 11,462,335
Stockholder loan ....................................... 644,591 648,147 --
Deferred income tax liability .......................... 186,039 184,658 117,429
Commitments and contingencies .......................... -- -- --
Redeemable common stock: 2,487,500 shares issued
and outstanding ....................................... -- 9,991,918 9,991,918 --
Stockholders' deficit:
Common stock: $.001 par value; 60,000,000 shares
authorized; 7,747,892 issued and outstanding in
1997; 9,296,723 issued and 9,216,496 outstanding
in 1998; 9,716,988 issued and 9,636,011
outstanding in 1999; 12,204,488 issued and
12,123,511 outstanding pro forma at June 30,
1999 ................................................ 7,748 9,297 9,717 $ 12,204
Capital in excess of par value ........................ 12,375,340 16,351,092 18,716,040 28,705,471
Treasury stock, 80,227 shares in 1998 and 80,977 in
1999, at cost ....................................... -- (57,764) (58,304) (58,304)
Accumulated other comprehensive income ................ 188,740 478,948 473,517 473,517
Notes receivable from officers/employees .............. -- (417,334) (417,334) (417,334)
Accumulated deficit ................................... (17,197,668) (22,700,612) (24,856,659) (24,856,659)
------------- ------------- ------------- -------------
Total stockholders' equity (deficit) ................. (4,625,840) (6,336,373) (6,133,023) $ 3,858,895
------------- ------------- ------------- =============
TOTAL LIABILITIES, REDEEMABLE
COMMON STOCK, AND STOCKHOLDERS'
DEFICIT ............................................... $ 1,606,535 $ 11,135,955 $ 15,438,659
============= ============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-3
<PAGE>
SMARTDISK CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
YEARS ENDED DECEMBER 31, ENDED JUNE 30,
------------------------------------------------- --------------------------------
1996 1997 1998 1998 1999
---------------- --------------- ---------------- --------------- ----------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues
Product sales ...................... $ 500,252 $ 892,530 $ 15,038,281 $ 3,789,979 $ 13,796,720
Royalties .......................... -- -- 284,298 182,323 196,020
------------- ------------ ------------ ------------ ------------
Total revenues ...................... 500,252 892,530 15,322,579 3,972,302 13,992,740
Cost of revenues .................... 366,693 300,678 12,600,330 3,252,518 10,271,018
------------- ------------ ------------ ------------ ------------
Gross profit ........................ 133,559 591,852 2,722,249 719,784 3,721,722
Operating expenses
Research and development ........... 720,009 1,411,986 1,607,950 684,871 2,453,491
Sales and marketing ................ 5,884 11,582 2,546,602 730,750 1,443,385
General and administrative ......... 3,418,010 3,184,552 4,149,191 2,085,899 1,971,408
Impairment loss .................... 7,807,157 -- -- -- --
------------- ------------ ------------ ------------ ------------
Total operating expenses ............ 11,951,060 4,608,120 8,303,743 3,501,520 5,868,284
------------- ------------ ------------ ------------ ------------
Operating loss ...................... (11,817,501) (4,016,268) (5,581,494) (2,781,736) (2,146,562)
Gain (loss) on foreign exchange ..... -- -- (47,678) (2,324) 29,639
Interest and other income ........... -- 8,210 75,770 63,705 51,900
Interest expense .................... (275) (514) (51,858) (47,058) (23,258)
------------- ------------ ------------ ------------ ------------
Net loss before income taxes ........ (11,817,776) (4,008,572) (5,605,260) (2,767,413) (2,088,281)
Income tax expense (benefit) ........ (2,347,876) (44,598) (102,316) (38,394) 67,766
------------- ------------ ------------ ------------ ------------
Net loss ............................ $ (9,469,900) $ (3,963,974) $ (5,502,944) $ (2,729,019) $ (2,156,047)
============= ============ ============ ============ ============
Net loss per share .................. $ (1.25) $ (0.51) $ (0.68) $ (0.35) $ (0.24)
============= ============ ============ ============ ============
Shares used in computing
net loss per share ................. 7,578,889 7,738,909 8,040,169 7,773,719 9,042,975
============= ============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
SMARTDISK CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
COMMON STOCK CAPITAL IN
-------------------- EXCESS OF COMPREHENSIVE
SHARES AMOUNT PAR VALUE LOSS
----------- -------- -------------- ---------------
<S> <C> <C> <C> <C>
BALANCE,
DECEMBER 31, 1995 ............ 7,350,000 $7,350 $ 176,725
Comprehensive loss:
Net loss .................... $ (9,469,900)
Foreign currency
translation ................ 181,207
------------
Comprehensive loss .......... $ (9,288,693)
============
Acquisition of SDL ............ 374,639 375 6,941,730
Contribution of stockholder
loan to capital .............. 3,908,823
-----------
BALANCE,
DECEMBER 31, 1996 ............ 7,724,639 7,725 11,027,278
Comprehensive loss:
Net loss .................... $ (3,963,974)
Foreign currency
translation ................ 7,533
------------
Comprehensive loss .......... $ (3,956,441)
============
Acquisition of SDL ............ 23,253 23 693,401
Contribution of stockholder
loan to capital .............. 654,661
-----------
BALANCE,
DECEMBER 31, 1997 ............ 7,747,892 7,748 12,375,340
Comprehensive loss:
Net loss .................... $ (5,502,944)
Foreign currency
translation ................ 290,208
------------
Comprehensive loss .......... $ (5,212,736)
============
Issuance of common stock for
trademarks ................... 150,000 150 (150)
Issuance of common stock ...... 666,250 666 3,164,334
Shares issued upon exercise of
options ...................... 699,863 700 511,601
Acquisition of SDL minority
interest ..................... 32,718 33 299,967
Repurchase of common stock.....
BALANCE,
DECEMBER 31, 1998 ............ 9,296,723 9,297 16,351,092
Comprehensive loss:
Net loss .................... $ (2,156,047)
Foreign currency
translation ................ (5,431)
------------
Comprehensive loss .......... $ (2,161,478)
============
Issuance of common stock ...... 250,000 250 1,099,750
Stock compensation ............ 76,500
Shares issued upon exercise of
options ...................... 47,875 48 175,448
Issuance of SDL shares ........ 8,872 9 65,216
Conversion of stockholder
loan into SDL shares ......... 76,018 76 648,071
Issuance of common stock
for license .................. 37,500 37 299,963
Repurchase of common stock.....
BALANCE,
JUNE 30, 1999 ................ 9,716,988 $9,717 $18,716,040
========= ====== ===========
<PAGE>
<CAPTION>
NOTES
ACCUMULATED RECEIVABLE
OTHER FROM TOTAL
ACCUMULATED COMPREHENSIVE OFFICERS/ TREASURY STOCKHOLDERS'
DEFICIT INCOME EMPLOYEES STOCK DEFICIT
---------------- --------------- ------------- ------------ ----------------
<S> <C> <C> <C> <C> <C>
BALANCE,
DECEMBER 31, 1995 ............ $ (3,763,794) $ -- $ -- $ -- $ (3,579,719)
Comprehensive loss:
Net loss .................... (9,469,900)
Foreign currency
translation ................ 181,207
Comprehensive loss .......... (9,288,693)
Acquisition of SDL ............ 6,942,105
Contribution of stockholder
loan to capital .............. 3,908,823
------------
BALANCE,
DECEMBER 31, 1996 ............ (13,233,694) 181,207 -- -- (2,017,484)
Comprehensive loss:
Net loss .................... (3,963,974)
Foreign currency
translation ................ 7,533
Comprehensive loss .......... (3,956,441)
Acquisition of SDL ............ 693,424
Contribution of stockholder
loan to capital .............. 654,661
------------
BALANCE,
DECEMBER 31, 1997 ............ (17,197,668) 188,740 -- -- (4,625,840)
Comprehensive loss:
Net loss .................... (5,502,944)
Foreign currency
translation ................ 290,208
Comprehensive loss .......... (5,212,736)
Issuance of common stock for
trademarks ...................
Issuance of common stock ...... 3,165,000
Shares issued upon exercise of
options ...................... (417,334) 94,967
Acquisition of SDL minority
interest ..................... 300,000
Repurchase of common stock..... (57,764) (57,764)
--------- ------------
BALANCE,
DECEMBER 31, 1998 ............ (22,700,612) 478,948 (417,334) (57,764) (6,336,373)
Comprehensive loss:
Net loss .................... (2,156,047)
Foreign currency
translation ................ (5,431)
Comprehensive loss .......... (2,161,478)
Issuance of common stock ...... 1,100,000
Stock compensation ............ 76,500
Shares issued upon exercise of
options ...................... 175,496
Issuance of SDL shares ........ 65,225
Conversion of stockholder
loan into SDL shares ......... 648,147
Issuance of common stock
for license .................. 300,000
Repurchase of common stock..... (540) (540)
--------- ------------
BALANCE,
JUNE 30, 1999 ................ $ (24,856,659) $473,517 $ (417,334) $ (58,304) $ (6,133,023)
============= ======== ========== ========= ============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
<PAGE>
SMARTDISK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------
1996 1997 1998
---------------- ---------------- ----------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .................................................... $ (9,469,900) $ (3,963,974) $ (5,502,944)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation .............................................. 130,494 227,089 613,777
Amortization .............................................. 1,653,914 179,346 410,917
Bad debt expense .......................................... -- -- 26,565
Provision for inventory obsolescence ...................... -- -- --
Foreign currency (gain) loss .............................. -- -- (31,235)
Employee stock option expense ............................. -- -- --
Deferred income tax benefit ............................... (2,347,876) (44,598) (102,316)
Impairment loss ........................................... 7,807,157 -- --
Changes in assets and liabilities:
(Increase) decrease in assets:
Accounts receivable ...................................... -- -- (3,763,316)
Inventories .............................................. 289,236 23,529 (1,394,524)
Prepaid expenses and other current assets ................ (25,237) (274,894) (80,660)
Deposits and other assets ................................ (20,525) 20,525 (176,942)
Increase (decrease) in liabilitities:
Accounts payable ......................................... 546,890 (397,416) 3,452,485
Deferred research and development contract revenue ....... -- -- --
Other accrued liabilities ................................ (4,584) 80,588 587,575
------------ ------------ ------------
Net cash used in operating activities ....................... (1,440,431) (4,149,805) (5,960,618)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment ........................ (200,821) (284,943) (1,019,878)
Increase in restricted cash ................................ -- -- (1,050,000)
------------ ------------ ------------
Net cash used in investing activities ....................... (200,821) (284,943) (2,069,878)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of exchangeable note ................ -- -- 5,000,000
Net proceeds from line of credit ........................... -- -- 2,247,718
Net proceeds (repayment) of stockholder loan ............... 1,450,844 3,709,527 (3,955,000)
Proceeds (repayment) of due to related parties ............. -- 1,045,000 (1,045,000)
Proceeds from sale of redeemable common stock .............. -- -- 4,950,000
Proceeds from sale of common stock ......................... -- -- 3,165,000
Proceeds from exercise of stock options .................... -- -- 94,967
Proceeds from sale of stock by SDL ......................... -- -- --
Purchase of treasury stock ................................. -- -- (57,764)
------------ ------------ ------------
Net cash provided by financing activities ................... 1,450,844 4,754,527 10,399,921
Effect of exchange rate fluctuations on cash ................ 4,490 1,973 220,525
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents ............ (185,918) 321,752 2,589,950
Cash and cash equivalents at beginning of period ............ 193,944 8,026 329,778
------------ ------------ ------------
Cash and cash equivalents at end of period .................. $ 8,026 $ 329,778 $ 2,919,728
============ ============ ============
SIGNIFICANT NON-CASH ACTIVITIES:
Acquisition of SDL/patents ................................. $ 6,942,105 $ 693,424 $ 300,000
Contribution/conversion of stockholder loan to capital ..... $ 3,908,823 $ 654,661 --
Exchange of note payable plus accrued
interest for redeemable common stock ...................... --- -- $ 5,041,918
Note receivable obtained for stock options ................. -- -- $ 417,334
Issuance of common stock for trademarks/license ............ $ 600,000
<PAGE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30,
---------------------------------
1998 1999
---------------- ----------------
(UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .................................................... $ (2,729,019) $ (2,156,047)
Adjustments to reconcile net loss to
net cash used in operating activities:
Depreciation .............................................. 265,484 471,317
Amortization .............................................. 154,572 251,409
Bad debt expense .......................................... 31,364 39,062
Provision for inventory obsolescence ...................... -- 32,900
Foreign currency (gain) loss .............................. 35,969 (29,639)
Employee stock option expense ............................. -- 76,500
Deferred income tax benefit ............................... (36,802) (67,229)
Impairment loss ........................................... -- --
Changes in assets and liabilities:
(Increase) decrease in assets:
Accounts receivable ...................................... (909,934) (5,247,718)
Inventories .............................................. (1,687,652) 1,279,808
Prepaid expenses and other current assets ................ (237,694) (759,890)
Deposits and other assets ................................ (84,320) 73,025
Increase (decrease) in liabilitities:
Accounts payable ......................................... 3,027,760 939,720
Deferred research and development contract revenue ....... -- 968,415
Other accrued liabilities ................................ 499,175 699,225
------------ ------------
Net cash used in operating activities ....................... (1,671,097) (3,429,142)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment ........................ (750,128) (1,745,601)
Increase in restricted cash ................................ (1,289,771) --
------------ ------------
Net cash used in investing activities ....................... (2,039,899) (1,745,601)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of exchangeable note ................ 5,000,000 --
Net proceeds from line of credit ........................... -- 2,207,370
Net proceeds (repayment) of stockholder loan ............... (4,258,321) --
Proceeds (repayment) of due to related parties ............. (1,045,000) --
Proceeds from sale of redeemable common stock .............. 4,950,000 --
Proceeds from sale of common stock ......................... 165,000 1,100,000
Proceeds from exercise of stock options .................... 94,967 175,496
Proceeds from sale of stock by SDL ......................... -- 65,225
Purchase of treasury stock ................................. (57,764) (540)
------------ ------------
Net cash provided by financing activities ................... 4,848,882 3,547,551
Effect of exchange rate fluctuations on cash ................ (104,387) 42,609
------------ ------------
Increase (decrease) in cash and cash equivalents ............ 1,033,499 (1,584,583)
Cash and cash equivalents at beginning of period ............ 329,778 2,919,728
------------ ------------
Cash and cash equivalents at end of period .................. $ 1,363,277 $ 1,335,145
============ ============
SIGNIFICANT NON-CASH ACTIVITIES:
Acquisition of SDL/patents ................................. --- --
Contribution/conversion of stockholder loan to capital ..... -- $ 648,147
Exchange of note payable plus accrued
interest for redeemable common stock ...................... $ 5,041,918 --
Note receivable obtained for stock options ................. $ 417,334 --
Issuance of common stock for trademarks/license ............ $ 600,000 $ 300,000
</TABLE>
The accompanying notes are an intregral part of these consolidated financial
statements.
F-6
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND NATURE OF OPERATIONS
ORGANIZATION AND NATURE OF OPERATIONS
SmartDisk Corporation ("SmartDisk" or the "Company") was incorporated on
March 5, 1997, and its predecessor, SmartDisk Security Corporation ("SDSC") was
incorporated on May 18, 1993. SDSC was substantially wholly-owned by Addison
Fischer ("Fischer").
From 1993 to 1995, SDSC exploited technology that it licensed under a
manufacturing license agreement with Fischer International Systems Corporation
("FISC"), another company substantially wholly-owned by Fischer. The patents
underlying the licensed technology were held by SmartDiskette GmbH ("SDG"), a
German company that is wholly-owned by SmartDiskette Limited ("SDL"), an
English company that was approximately 37% owned by Fischer through May 1996.
SDG licensed these patents to SDL. SDL in turn entered into a manufacturing
license agreement with FISC that FISC subsequently assigned to SDSC. The
license agreement covered the manufacture and sale of solid state diskettes
relating to the fields of data security and validation and computer security
and access control. For the period January 1, 1996 through December 31, 1997,
FISC, pursuant to an operating agreement with SDSC, conducted all operations
and development activities on behalf of SDSC. During this period, SDSC (through
FISC) developed several products using proprietary, high-density flash memory
technology. These products are hereafter referred to as the "SmartDisk
Products." The SmartDisk Products consist primarily of FlashPath (used to
read/write flash memory cards) and Smarty (used to read/write smart cards).
SDSC reimbursed FISC for the cost of services provided by FISC under the
operating agreement. In addition, FISC retained 25% of the gross sales price of
SmartDisk Products distributed by it on behalf of SDSC.
On March 21, 1997, FISC and Toshiba Corporation ("Toshiba") entered into a
memorandum of understanding in which the parties agreed to exploit the
SmartDisk Products. SmartDisk commenced operations January 1, 1998. Effective
on that date, SDSC's operating agreement with FISC was terminated.
On May 26, 1998, an agreement was finalized with Toshiba and FISC in order
to, among other things, capitalize SmartDisk. SDSC stockholders exchanged all
the issued and outstanding shares of SDSC for 7,350,000 shares of common stock
of SmartDisk, Toshiba contributed $9,991,918 (see note 7) for 2,487,500 shares
of redeemable common stock and FISC assigned trademarks to SmartDisk in
exchange for 150,000 shares of common stock. In conjunction with the
capitalization, SDSC was merged into SmartDisk. The merger was a combination of
entities under common control and accounted for at historical cost. The
accounts of SmartDisk and SDSC are combined in the accompanying financial
statements.
In May 1996 and May 1997, Fischer increased his ownership of SDL to 87%
and 92%, respectively. In May 1998, Phoenix House Investments, LLC ("Phoenix
House"), an investment company substantially owned by Fischer, acquired the
remaining outstanding interests of SDL through the issuance of common stock
valued at approximately $300,000. In May 1999, the stockholders of SDL
exchanged all their shares of SDL for 515,500 shares of common stock of
SmartDisk and SDL became a wholly owned subsidiary of SmartDisk. The merger was
a combination of entities under common control and accounted for at historical
cost. The individual financial statements of SmartDisk and SDL are combined in
the accompanying financial statements from May 22, 1996, the date SDL came
under common control. The accounts of SDL were adjusted as of that date to
reflect a new basis under the purchase accounting method.
F-7
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 1. ORGANIZATION AND NATURE OF OPERATIONS--(CONTINUED)
The Company serves customers in the electronics, banking and other
consumer markets. Principal geographic markets for the Company's products
include the United States, Japan, Europe and other world markets.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
In August 1999, the Company effected a reverse stock split of one for
four. The financial statements have been restated to give retroactive
recognition to the reverse stock split in the prior periods, including all
references in the financial statements to number of shares and per share
amounts.
In August 1999, the Company amended and restated its Certificate of
Incorporation such that the number of shares of authorized capital stock was
increased to 65,000,000 shares, consisting of 60,000,000 shares of common stock
with a par value of $0.001 per share and 5,000,000 shares of preferred stock
with a par value $0.001 per share.
The accompanying consolidated financial statements include the accounts of
SmartDisk, SDSC and SDL (from May 1996), entities that were under common
control and subsequently merged to form the entity that is now known as
SmartDisk Corporation. All significant intercompany balances and transactions
have been eliminated in consolidation.
Common stock shares and amounts as presented in the accompanying financial
statements have been retroactively adjusted to reflect the effect of the
mergers of SDL and SDSC into SmartDisk.
CERTAIN UNCERTAINTIES AND RISKS
The Company sells to original equipment manufacturers, retailers, and
distributors in the United States, Japan, Europe and other world markets.
However, the majority of the Company's sales are to Japanese customers.
Japanese sales as well as related expenses are denominated in Yen and,
accordingly, are subject to the risks associated with fluctuations in exchange
rates between the Yen and the US dollar. The Company does not hedge against
foreign currency exposure.
In the normal course of business, the Company extends unsecured credit to
its customers for the sale of products. Credit terms generally range from 30 to
150 days receivables with extended credit terms secured by promissory notes.
The Company evaluates and monitors the credit worthiness of each customer on a
case by case basis. Allowances are maintained for potential credit losses.
A limited number of customers account for a substantial portion of the
Company's revenues. Further, one product accounts for a substantial portion of
the Company's revenues. Sales of the Company's products will vary as a result
of fluctuations in market demand.
Certain raw materials used by the Company in the manufacture of its
products are available from a limited number of suppliers. The Company is
dependent on its manufacturers to allocate a sufficient portion of their
manufacturing capacity to meet the Company's needs.
F-8
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from these estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash, accounts receivable, accounts payable and
other accrued liabilities in the accompanying balance sheet approximates fair
value because of the short-term maturity of these financial instruments. The
fair value of the restricted cash and line of credit approximates market, as
the interest rates on these financial instruments are market rates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and money market instruments
with short term maturities of 90 days or less.
RESTRICTED CASH
Restricted cash is composed of a time deposit that the Company maintains
as collateral for a line of credit.
INVENTORIES
Inventories are stated at the lower of cost or market with cost being
determined on a first-in, first-out basis.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost less accumulated depreciation.
All major expenditures for production equipment are capitalized and depreciated
over the economic life of the asset. The costs of repairs and maintenance are
charged to expense in the year when they are incurred. Depreciation is computed
using the straight-line and declining balance methods over the estimated useful
lives of 2 to 15 years. In addition, certain production equipment is
depreciated using the units of production method. The units of production
method depreciates the property over the estimated life cycle production
quantities. The monthly depreciation cost is calculated by using the number of
pieces produced times the cost per piece computed from the estimated total
production quantity.
IMPAIRMENT OF LONG-LIVED ASSETS
In the event that facts and circumstances indicate that the costs of
assets may be impaired, an evaluation of recoverability is performed. If an
evaluation is required, the estimated future undiscounted cash flow associated
with the asset is compared to the asset's carrying amount to determine if a
write-down to market value is required.
SOFTWARE DEVELOPMENT COSTS
Development costs incurred in the research and development of new software
products and enhancements to existing software products are expensed as
incurred until technological feasibility has
F-9
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
been established, at which time certain development costs required to attain
general production release would be capitalized. To date, the Company's
software development has essentially been completed concurrent with the
establishment of technological feasibility, and, accordingly, no costs have
been capitalized.
INCOME TAXES
The Company accounts for income taxes under SFAS No. 109, "Accounting for
Income Taxes". Deferred income tax assets and liabilities are determined based
upon differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse.
REVENUE RECOGNITION
Sales revenue is recognized at the time of shipment to customers. Royalty
revenue consists of royalties earned on sales of licensed products. Royalty
revenues are recognized when earned based upon contractual agreement. To date,
all of the Company's royalties relate to the licensing of one software product
to FISC. The Company has no continuing obligations under this licensing
agreement. Revenues from research and development contracts are recognized when
earned based upon achievement of contract milestones.
FOREIGN CURRENCY TRANSACTIONS
Substantially all of the Company's sales are made through a Japanese
subsidiary. This subsidiary and other foreign subsidiaries have their local
currency as their functional currency. Their assets and liabilities are
translated to the US dollar at the current exchange rates in effect at the
balance sheet date. Items of revenue and expense are translated using average
exchange rates in effect for the period in which the items occur. The resulting
gains and losses from translation are included as a component of stockholders'
equity.
Certain cash time deposits and inter-company accounts of the Japanese
subsidiary are dollar-denominated balances. These balances are remeasured to
the functional currency using the current exchange rate at the balance sheet
date, and resulting adjustments are reflected in the gain (loss) on foreign
exchange account included in the statement of operations. Inter-company gains
(losses) included in this account for the year ended December 31, 1998 and the
six months ended June 30, 1998 (unaudited) and 1999 totaled $170,416, $0 and
$(53,855), respectively.
STOCK BASED COMPENSATION
The Company applies the intrinsic value method in accounting for its stock
options. Accordingly, no compensation expense has been recognized for options
granted with an exercise price equal to market value at the date of grant.
NET LOSS PER SHARE
Basic net income (loss) per share as disclosed in the statement of
operations, is based on the weighted effect of all common shares issued and
outstanding, and is calculated by dividing net income
F-10
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
(loss) by the weighted average shares outstanding during the period. Diluted
net income (loss) per share would be calculated by dividing net income by the
weighted average common shares used in the basic calculation plus the number of
common shares that would be issued assuming conversion of all potentially
dilutive common shares outstanding. Diluted net income (loss) is not presented,
as the effect of including potentially dilutive securities would be
anti-dilutive. Potentially dilutive securities include common stock options and
redeemable common stock. Subsequent to June 30, 1999, the Company issued
400,000 shares of common stock and granted 86,000 common stock options.
The Company has outstanding 2,487,500 shares of redeemable common stock
that will convert to nonredeemable common stock if the Company becomes a
publicly traded company prior to February 24, 2000. Pro forma net loss per
share assuming expiration of the redemption feature and inclusion of the
redeemable common stock shares in weighted average shares outstanding, for the
year ended December 31, 1998 and the six months ended June 30, 1999 would be
$0.57 and $0.19 per share, respectively.
Net loss per share has been computed reflecting the retroactive adjustment
of outstanding shares related to the mergers of SDL and SDSC into SmartDisk.
ADVERTISING
Advertising costs are charged to expense as incurred, advertising expenses
for 1996, 1997 and 1998 were $3,539, $3,785 and $214,002, respectively, and for
the six months ended June 30, 1998 (unaudited) and 1999 were $15,350 and
$37,044, respectively.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARD
In June 1998, the FASB issued Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. The Company expects to adopt the new
Statement effective January 1, 2001. The Statement will require the Company to
recognize all derivatives on the balance sheet at fair value. The Company does
not anticipate that the adoption of this Statement will have a significant
effect on its results of operations or financial position.
NOTE 3. INVENTORY
Inventories consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- JUNE 30,
1997 1998 1999
---------- ------------- -----------
<S> <C> <C> <C>
Finished goods ..................... $ -- $1,687,905 $ 403,616
Raw materials ...................... 294,496 1,115 5,596
-------- ---------- ---------
Total inventories .................. $294,496 $1,689,020 $ 409,212
Allowance for obsolescence ......... -- -- (32,900)
-------- ---------- ---------
Net inventory ...................... $294,496 $1,689,020 $ 376,312
======== ========== =========
</TABLE>
F-11
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 4. PROPERTY AND EQUIPMENT
Property and equipment consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------- JUNE 30,
1997 1998 1999
------------- ------------- -------------
<S> <C> <C> <C>
Production equipment .............................. $ 396,307 $ 702,779 $2,287,715
Furniture and fixtures ............................ 9,789 191,576 220,560
Software .......................................... 31,112 167,519 290,120
---------- ---------- ----------
Property and equipment, at cost ................... $ 437,208 $1,061,874 $2,798,395
Accumulated depreciation and amortization ......... (227,089) (379,860) (842,097)
---------- ---------- ----------
Property and equipment, net ....................... $ 210,119 $ 682,014 $1,956,298
========== ========== ==========
</TABLE>
NOTE 5. INTANGIBLE ASSETS AND IMPAIRMENT LOSS
The financial statements of SDL are combined with those of the Company as
of May 22, 1996, the date that SDL came under common control ("1996
acquisition") as a result of the Company's principal stockholder acquiring an
87% ownership interest in SDL through a series of acquisitions. The purchase
price as of May 22, 1996 totaled approximately $7 million, all of which was
allocated to patents. In addition, goodwill and a corresponding deferred tax
liability totaling approximately $2.3 million were recorded to reflect the tax
effect of the acquisition. The intangibles were being amortized over their
estimated useful life of three years. Subsequently, pursuant to SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of", the Company evaluated the recoverability of the recorded
patents and goodwill. SDL was acquired for its two developed products. The
potential customer (U.S. Government) for one of these products abandoned an
initiative in late 1996 for which this product was to be used and management's
assessment was that there was no alternative use for this product. The other
product did not meet management's market expectations. Further, no significant
sales ever occurred related to the patented products and such products were
discontinued in late 1996. The technology underlying the patents was assessed
by management to be obsolete and the related patents deemed worthless.
Accordingly, during 1996, the Company recorded an impairment loss of $7,807,157
to write-off the remaining unamortized cost of the patents and related
goodwill.
On May 22, 1997, an additional 5% ownership interest in SDL was purchased
for approximately $700,000 through the exercise of a put option given to SDL
stockholders in connection with the 1996 acquisition. In May 1998, the
remaining minority interest in SDL was acquired in exchange for common stock of
Phoenix House valued at approximately $300,000. All of the additional purchase
price was allocated to new patents that were issued subsequent to the 1996
acquisition, and unrelated to the patented technology that became worthless in
1996. In addition, goodwill and a corresponding deferred tax liability totaling
approximately $330,000 were recorded to reflect the related tax effect. These
intangible assets are being amortized on a straight line basis over their
estimated useful lives (through 2000).
On June 30, 1999 the Company issued 37,500 shares of its common stock to
SanDisk Corporation ("SanDisk") in exchange for a license to utilize certain
patented technology developed by SanDisk. The Company is amortizing the license
on a straight-line basis over the ten year term of the license. In addition,
the Company is required to pay a royalty to SanDisk on net revenues from direct
sales to customers other than SanDisk of products developed by the Company
utilizing this licensed technology.
F-12
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 5. INTANGIBLE ASSETS AND IMPAIRMENT LOSS--(CONTINUED)
Intangible assets consist of:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------- JUNE 30,
1997 1998 1999
------------- ------------- -------------
<S> <C> <C> <C>
Patents ............................... $ 695,615 $ 998,334 $ 985,758
Goodwill .............................. 231,871 332,791 326,966
License ............................... -- -- 300,000
---------- ---------- ----------
927,486 1,331,125 1,612,724
Less accumulated amortization ......... (179,349) (590,147) (841,556)
---------- ---------- ----------
Intangible assets, net .............. $ 748,137 $ 740,978 $ 771,168
========== ========== ==========
</TABLE>
NOTE 6. BANK LINE OF CREDIT
The Company's wholly-owned Japanese subsidiary entered into an agreement
with the Bank of Tokyo-Mitsubishi, Ltd. on June 8, 1998, revised on January 29,
1999, for a Line of Credit with maximum borrowing capacity of $2.52 million
(305 million Yen). The facility is collateralized by a time deposit and
accounts receivable. The Company maintains a time deposit with the bank that
has a balance at June 30, 1999 of $1,050,000 (127,155,000 Yen). The Company may
borrow up to 90% of this amount. In addition, accounts receivable of up to
$1.65 million (200 million Yen) of specified trade customers may be used as
additional collateral. The interest rate on borrowings under the credit
facility is 1.375% per year and the credit facility must be renewed every six
months. The current agreement expires on December 25, 1999. The Company also
discounts certain short-term promissory notes received from trade customers
with the bank. Bank borrowings collateralized by promissory notes totaled
$1,382,000 at December 31, 1998 and $3,523,000 at June 30, 1999.
Interest paid during the periods ended December 31, 1998, June 30, 1998
(unaudited) and 1999 amounted to $5,017, $0 and $23,227, respectively.
NOTE 7. COMMITMENTS AND CONTINGENCIES
LEASES
Through May 31, 1999, the Company leased space for its corporate
headquarters from a related party, FISC, on a month-to-month basis. There was
no formalized agreement and the expense was accrued and paid monthly based on a
percent of usage basis. As of June 1, 1999, the Company assumed from FISC a
facilities operating lease with an unrelated lessor that continues through
December 31, 2001. The Company's Japanese subsidiary leases office space under
a two year operating lease that commenced in April 1998. Total rent expense for
1996, 1997 and 1998 and for the six months ended June 30, 1998 (unaudited) and
1999 was $14,155, $36,995, $261,399, $89,500 and $179,718, respectively. Rent
expense incurred related to FISC for these same periods totaled $14,155,
$36,995, $135,290, $64,301 and $58,578, respectively.
F-13
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7. COMMITMENTS AND CONTINGENCIES--(CONTINUED)
The table below sets forth minimum payments for the years indicated under
leases with remaining terms in excess of one year, at June 30, 1999:
<TABLE>
<S> <C>
1999 ............. $ 59,063
2000 ............. 124,031
2001 ............. 130,233
</TABLE>
CONTINGENCIES
The Company relies on a combination of patents, trademarks, copyright and
trade secret laws, confidentiality procedures and licensing arrangements to
protect its intellectual property rights. There can be no assurance that there
will not be any disputes regarding the Company's intellectual property rights.
Specifically, there can be no assurance that any patents held by the Company
will not be invalidated, that patents will be issued for any of the Company's
pending applications or that any claims allowed from existing or pending
patents will be of sufficient scope or strength or be issued in the primary
countries where the Company's products can be sold that will provide meaningful
protection or any commercial advantage to the Company. Additionally,
competitors of the Company may be able to design around the Company's patents.
REDEEMABLE COMMON STOCK
In connection with the agreement that was finalized in May 1998 (see Note
1), Toshiba received 2,487,500 shares of redeemable common stock in exchange
for $9,991,918 (consisting of $4,950,000 cash, the exchange of a $5,000,000
note and accrued interest of $41,918). In March 1998, SmartDisk had executed a
4% note with Toshiba for $5,000,000 that was exchangeable into common stock at
$4 per share. The terms of the agreement provided Toshiba a put option that is
exercisable on February 24, 2000 and for a period of ninety days from that
date. This option provides that the Company may be asked to purchase all of the
redeemable common stock shares for a total of $9,950,000 plus 4% simple
interest per year. This right terminates if the Company completes an initial
public offering prior to the exercise date of the option. The redeemable common
stock will convert to nonredeemable common stock if the Company becomes a
publicly traded company prior to February 24, 2000 or the put option is not
exercised. In addition, Toshiba received Board of Director representation and
registration rights with regard to its common stock ownership in the Company.
The redeemable common stock has a redemption amount at June 30, 1999 of
$10,475,330.
Unaudited pro forma stockholders' equity at June 30, 1999 as set forth on
the accompanying balance sheets reflects the conversion of the redeemable
common stock, which will occur if a public offering is completed, as if such
conversion had occurred on June 30, 1999.
EMPLOYMENT AGREEMENTS
The Company has entered into employment agreements with certain of its
employees. These agreements stipulate, among other things, severance and
benefit arrangements in the event of termination. In addition, the agreements
include confidentiality provisions, invention assignment provisions, and
covenants not to compete.
F-14
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 8. STOCK BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation," requires use of
option valuation models that were not developed for use in valuing employee
stock options.
The Company's 1998 Employee Stock Option Plan has authorized the grant of
options to employees including members of the Company's Board of Directors who
are employees of the Company for up to 1,454,545 shares of the Company's common
stock of which 55,315 remain available as of June 30, 1999. Options granted
under the plan have vesting dates ranging from four to five years and all
options granted have a ten year contractual life.
The Company's 1998 Directors and Consultants Stock Option Plan has
authorized the grant of options to officers, directors, consultants and other
independent contractors (including members of the Company's Board of Directors
who are not employees of the Company) for up to 250,000 shares of the Company's
common stock of which 77,219 remain available as of June 30, 1999. Options
granted under the plan have vesting dates ranging from four to five years and
all options granted have a ten year contractual life.
The Company had reserved 1,704,545 shares of common stock for issuance
under the aforementioned stock option plans. At June 30, 1999, 132,534 options
remain available for future grant.
In July 1999 the Company's 1998 Employee Stock Option Plan and 1998
Directors and Consultants Stock Option Plan were terminated.
In July 1999, the Company established the 1999 Incentive Compensation Plan
(the 1999 Plan). Pursuant to the terms of the 1999 Plan, the Company may grant
participants stock options, stock appreciation rights, restricted stock,
deferred stock, other stock-related awards and performance or annual incentive
awards that may be settled in cash, stock or other property (collectively, the
Awards). Under the 1999 Plan, the total number of shares of common stock that
may be subject to the granting of Awards at any time during the term of the
1999 Plan shall equal 2,500,000 shares, plus the number of shares with respect
to which Awards previously granted under the 1999 Incentive Plan that terminate
without being exercised, and the number of shares of common stock that are
surrendered in the payment of any Awards or any tax withholding requirements.
No options have been granted to date under the 1999 Plan.
Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock option under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 1998 and 1999; volatility factor of the expected market price
of the Company's common stock of .80; risk-free interest rate of 5.25% and a
weighted-average expected life of the option of 5 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option
F-15
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 8. STOCK BASED COMPENSATION--(CONTINUED)
valuation models require the input of highly subjective assumptions including
the expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of its
employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The company's
pro forma information follows:
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
---------------- -----------------------------------
1998 1998 1999
---------------- ---------------- ----------------
(UNAUDITED)
<S> <C> <C> <C>
Pro forma net loss ............... $ (5,620,529) $ (2,766,811) $ (2,351,972)
Pro forma loss per share ......... $ (0.70) $ (0.36) $ (0.26)
</TABLE>
A summary of the Company's stock option activity, and related information
for the year ended December 31, 1998 and the six months ended June 30, 1999 are
as follows:
<TABLE>
<CAPTION>
NUMBER OF WEIGHTED AVERAGE
OPTIONS EXERCISE PRICE
------------- -----------------
<S> <C> <C>
Outstanding at December 31, 1997 ......... -- --
Options granted with exercise prices
equal to fair market value ............ 1,041,613 $ 1.29
Options granted with exercise prices
less than fair market value ........... 25,000 4.00
Options exercised ....................... (699,863) 0.73
Options canceled ........................ (750) 0.72
---------
Outstanding at December 31, 1998 ......... 366,000 $ 2.54
---------
Options granted with exercise prices
equal to fair market value ............ 792,500 6.98
Options exercised ....................... (47,875) 3.67
Options canceled ........................ (205,375) 2.64
---------
Outstanding at June 30, 1999 ............. 905,250 $ 6.36
=========
</TABLE>
The weighted average fair value of options granted during the year ended
December 31, 1998 and the six months ended June 30, 1999 with exercise prices
equal to market value was $0.84 and $4.71, respectively.
The weighted average fair value of options granted during the year ended
December 31, 1998 with exercise prices less than market value was $3.40.
During the six months ended June 30, 1999, compensation expense of $76,500
was recognized relating to the accelerated vesting of 21,000 options,
exercisable at $0.72 per share.
As of December 31, 1998 and June 30, 1999, 513,136 and 432,344 shares of
common stock issued upon the exercise of 699,864 options during 1998 remain
non-vested. Vesting of this restricted stock is subject to the vesting
provisions of the original option award.
F-16
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 8. STOCK BASED COMPENSATION--(CONTINUED)
The following table summarizes information about stock options outstanding
as of December 31, 1998 and June 30, 1999.
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS EXERCISABLE OPTIONS
--------------------------------------------------- ----------------------------
WEIGHTED AVERAGE
WEIGHTED AVERAGE REMAINING WEIGHTED AVERAGE
RANGE OF EXERCISE PRICE SHARES EXERCISE PRICE CONTRACTUAL LIFE SHARES EXERCISE PRICE
- ------------------------ --------- ------------------ ------------------ -------- -----------------
<S> <C> <C> <C> <C> <C>
December 31, 1998
$0.72 - $1.00 171,000 $ 0.77 9.1 years 2,250 $ 0.72
$4.00 - $4.80 195,000 $ 4.08 9.7 years -- --
- ------------------------ ------- -----
$0.72 - $4.80 366,000 $ 2.54 9.4 years 2,250 $ 0.72
======= =====
June 30, 1999
$0.72 - $1.00 58,750 $ 0.76 8.6 years 17,188 $ 0.75
$4.00 - $8.00 846,500 $ 6.73 9.7 years 4,969 $ 4.43
- ------------------------ ------- ------
$0.72 - $8.00 905,250 $ 6.36 9.7 years 22,157 $ 1.57
======= ======
</TABLE>
NOTE 9. EMPLOYEE BENEFIT PLANS
Effective January 1, 1998, for the benefit of qualified employees, the
Company became a participant in a tax deferred savings plan offered to
employees of FISC. The plan is designed to provide employees with an
accumulation of funds at retirement. Qualified employees may elect to make pre
tax contributions into the plan for up to 15% of their annual compensation, up
to a maximum of $10,000 per year. The Company may make annual contributions to
the plan at the discretion of the Board of Directors. The Company's matching
contributions are earned by the employee based on a straight line, five year
vesting schedule. For the year ended December 31, 1998, and the six months
ended June 30, 1998 (unaudited) and 1999, the Company made matching
contributions of $10,747, $4,840, and $15,809, respectively.
In July 1999, the Company established the 1999 Employee Stock Purchase
Plan (the Plan). The Plan provides for the issuance of a maximum of 465,000
shares of common stock pursuant to the exercise of nontransferable options
granted to participating employees. The Plan will enable eligible employees who
have completed a service requirement to purchase shares of common stock for 85%
of market price of the stock, up to 25% of the participant's total compensation
excluding bonuses and commissions. The Purchase Plan will take effect upon
completion of the Company's initial public offering.
F-17
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 10. INCOME TAXES
The United States and foreign components of loss from continuing
operations before income taxes are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
------------------------------------------------------ -----------------------------------
1996 1997 1998 1998 1999
---------------- ---------------- ---------------- ---------------- ----------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
United States ......... $ (2,118,417) $ (3,462,924) $ (4,584,045) $ (2,469,735) $ (3,140,297)
Foreign ............... (9,699,359) (545,648) (1,021,215) (297,678) 1,052,016
------------- ------------ ------------ ------------ ------------
Total ............... $ (11,817,776) $ (4,008,572) $ (5,605,260) $ (2,767,413) $ (2,088,281)
============= ============ ============ ============ ============
</TABLE>
The income tax benefit for periods prior to 1999 as presented in the
statements of operations relates to the reduction of the deferred income tax
liability associated with the identified intangible assets. The income tax
expense for the six months ended June 30, 1999 consists of a foreign tax
expense of $130,418 and a deferred income tax benefit of $62,652 related to the
intangible assets.
The significant components of the Company's deferred income taxes are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------- JUNE 30,
1997 1998 1999
------------- --------------- ---------------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carry forwards ......... $ 770,243 $ 2,615,236 $ 3,081,774
Depreciation and amortization ............. -- 18,377 16,953
Accrued expenses .......................... -- 9,225 13,837
Foreign tax credit ........................ -- -- 198,358
---------- ------------ ------------
Deferred tax assets ....................... 770,243 2,642,838 3,310,922
Less valuation allowance ................ (770,243) (2,642,838) (3,310,922)
---------- ------------ ------------
Net deferred tax assets ..................... -- -- --
Deferred tax liabilities:
Acquired intangibles ...................... (186,039) (184,658) (117,429)
---------- ------------ ------------
Total net deferred taxes .................... $ (186,039) $ (184,658) $ (117,429)
========== ============ ============
</TABLE>
F-18
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 10. INCOME TAXES--(CONTINUED)
The reconciliation of the U.S. federal statutory income tax rate to the
effective income tax rate is:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
-------------------------------------------- -----------------------------
1996 1997 1998 1998 1999
-------------- -------------- -------------- -------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Federal income tax benefit .................. (34.00)% (34.00)% (34.00)% (34.00)% (34.00)%
State taxes, net of federal benefit ......... ( 3.63) ( 3.63) ( 3.63) ( 3.63) ( 3.63)
Foreign tax rate differential ............... 3.80 0.63 ( 0.13) 0.33 3.26
Non-deductible items ........................ -- -- 1.38 0.11 2.79
Goodwill .................................... 6.55 0.37 0.13 0.52 0.71
Recognition of net deferred tax
assets from change in SDSC status -- -- ( 0.17) -- --
S corporation loss reported by
stockholders ............................... 6.75 32.51 -- -- --
Change in valuation allowance ............... 0.67 3.02 34.01 35.21 33.60
Other ....................................... -- -- 0.61 0.07 0.47
------ ------ ------ ------ ------
(19.86)% ( 1.10)% ( 1.80)% ( 1.39)% 3.2 %
====== ====== ====== ====== ======
</TABLE>
Prior to May 1998, SDSC elected to be taxed as an S corporation under the
Internal Revenue Code. As a result, the taxable income or losses for periods
prior to May 1998 were reported by the stockholders on their individual income
tax returns. Upon the conversion from an S corporation to a C corporation, SDSC
became subject to income tax. Subsequent to the conversion from an S
corporation to a C corporation, SDSC was merged into SmartDisk, a C
corporation.
SFAS 109 requires a valuation allowance to reduce the deferred tax assets
reported if, based on the weight of the evidence, it is more likely than not
that some portion or all of the deferred tax assets will not be realized. After
consideration of all the evidence, both positive and negative, management has
determined that a valuation allowance of approximately $770,000, $2,643,000 and
$3,311,000 at December 31, 1997 and 1998, and June 30, 1999, respectively, is
necessary to reduce the deferred tax assets to the amount that will more likely
than not be realized. The change in valuation allowance amounted to
approximately $121,000, $1,873,000 and $668,000 for December 31, 1997 and 1998,
and June 30, 1999, respectively.
At December 31, 1998 and June 30, 1999, the Company had United States and
foreign net operating loss carry forwards for tax purposes as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 JUNE 30, 1999
---------------------------- ---------------------------
JURISDICTION AMOUNT EXPIRATION AMOUNT EXPIRATION
- --------------------------- ------------- ------------ ------------- -----------
<S> <C> <C> <C> <C>
United States .......... $4,932,000 2018 $6,085,000 2018-2019
United Kingdom ......... $2,343,000 Unlimited $2,400,000 Unlimited
Japan .................. $ 377,000 2003 $ 0
N/A
</TABLE>
F-19
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 11. SEGMENT INFORMATION
The Company adopted SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise," replacing the
"industry segment" approach with the "management" approach. The management
approach designates the internal organization that is used by management for
making operating decisions and assessing performance as the source of the
Company's reportable segments. SFAS No. 131 also requires disclosures about
products and services, geographic areas and major customers. The Company
operates in one reportable business segment.
Sales to foreign markets and to significant customers as a percentage of
the Company's total revenues were as follows:
<TABLE>
<CAPTION>
YEARS ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
------------------------------ -----------------------
1996 1997 1998 1998 1999
-------- -------- -------- ------------ --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Foreign markets:
Asian and Pacific Rim Market ......... --% --% 84% 77% 83%
United States ........................ 75 82 10 13 13
Europe ............................... 25 18 6 10 4
-- -- -- -- --
100% 100% 100% 100% 100%
=== === === === ===
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
------------------------ --------------------
1996 1997 1998 1998 1999
------ ------ ------ ------------ -----
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Significant customers:
FISC ................ 100% 100% 14% 20% 11%
FujiFilm ............ -- -- 38 34 29
Olympus ............. -- -- 32 20 36
Hagiwara ............ -- -- 4 11 6
</TABLE>
The following is a summary of the carrying amounts of the Company's
foreign net assets (liabilities) by geographic area in which they are located:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, JUNE 30,
1997 1998 1999
-------------- -------------- -------------
<S> <C> <C> <C>
Asia and Pacific Rim ......... $ -- $1,830,076 $2,575,751
Europe ....................... (28,263) (46,025) 284,132
</TABLE>
The following is a summary of the Company's foreign long-lived assets by
geographic area in which they are located:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, JUNE 30,
1997 1998 1999
-------------- -------------- -------------
<S> <C> <C> <C>
Asia and Pacific Rim ......... $ -- $281,347 $1,204,681
Europe ....................... 757,926 750,821 480,522
</TABLE>
F-20
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 12. RELATED PARTY TRANSACTIONS
Material related party transactions that have been entered into by the
Company that are not disclosed otherwise in these notes are summarized below.
As outlined in Note 1, SmartDisk (including SDSC and SDL) and FISC were
under the common ownership of Fischer. Further, there were various transactions
between SmartDisk and FISC, such as sharing of certain general and
administrative resources, the purchases/sales of products and services and
similar transactions. In the opinion of management, the allocations were
reasonable and reflect all of the cost of the Company's doing business.
During 1996 and 1997, FISC provided operating services to SmartDisk
pursuant to an operating agreement. FISC retained 25% of the gross sales price
of SmartDisk Products distributed by it on behalf of the Company. In addition,
FISC allocated direct expenses attributable to the Company such as cost of
sales, product development and depreciation, and indirect expenses such as
selling, general and administrative expenses. The direct expense allocation was
based on actual expenses incurred and the indirect expense allocation was based
upon a pro rata allocaton of the total expenses incurred by FISC based upon
management's estimate of the percentage attributable to the Company. All of the
Company's revenues for those years and operating expenses totaling
approximately $2.3 million in 1996 and $4.0 million in 1997 were recognized or
incurred by FISC on behalf of SmartDisk. Management estimates that had the
Company operated on a stand-alone basis for those years, expenses would have
approximated the amounts reported.
As a direct result of this operating arrangement between FISC and
SmartDisk, the Company's stockholder loan from Fischer was increased by
$1,450,844 in 1996 and $3,158,817 in 1997 representing funding of SmartDisk
operations by Fischer through FISC. Stockholder loan amounts totaling
$3,908,823 in 1996 and $654,661 in 1997 were contibuted to capital. In
addition, stockholder loan amounts totaling $644,591 and $648,147 at December
31, 1997 and 1998, respectively, represented advances made by Fischer and
related companies to fund the operations of SDL. Those advances, which were
non-interest bearing and due upon demand, were converted into 386,841 shares of
common stock of SDL in May 1999, which in turn were exchanged for 76,018 shares
of SmartDisk.
At December 31, 1997, the Company owed $1,045,000 to FISC and $3,955,000
to Fischer, which represented non-interest amounts advanced to fund the
Company's operations. These amounts were repaid in 1998.
In connection with the 1998 agreement (see Note 1), the Company was
granted a non-exclusive license to certain patents relating to the interface
with Toshiba's SmartMedia cards. In September 1998, this license was amended to
expand the field of use for the license. In return, the Company agreed to pay a
1/2% royalty on products covered by the Toshiba patents. Royalty expenses
pertaining to this license were $68,752 in 1998, and $15,171, and $25,555 for
the six months ended June 30, 1998 (unaudited) and 1999, respectively.
The Company has entered into various strategic agreements with related
parties to sell, manufacture and distribute products. In addition, the Company
procures certain engineering services from a strategic investor. During 1998,
and for the six months ended June 30, 1998 (unaudited) and 1999, approximately
34%, 100% and 13%, respectively, of the Company's sales were to related
parties. During 1998 and for the six months ended June 30, 1998 (unaudited) and
1999, purchases of products and services of approximately $14.0 million, $4.7
million and $9.3 million, respectively, were made from related parties.
F-21
<PAGE>
SMARTDISK CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 12. RELATED PARTY TRANSACTIONS--(CONTINUED)
Pursuant to license and distribution agreements entered into in 1998
between FISC and the Company, FISC was granted the right to license and
distribute the Company's products through 2001. For this right, FISC agreed to
pay to the Company royalties ranging from 5% to 33.3% of net revenue derived
from SmartDisk product sales. All of the Company's royalty revenues are from
FISC.
Pursuant to operating agreements entered into in 1998, FISC provides
operating assistance to the Company consisting of services, facilities and
shared equipment. The Company's share of expenses for these services is based
on an internal analysis of the relative amount of time devoted to its business
by employees of FISC as well as the overhead charges attributable to these
employees. The Company recorded operating expenses related to these agreements
for the year ended December 31, 1998 and the six months ended June 30, 1998
(unaudited) and 1999 of approximately $1,500,000, $483,000 and $166,000,
respectively.
Three of the Company's principal stockholders have the right to require
the Company to file a registration statement to enable them to sell their
shares
During February 1999, the Company loaned $60,000 to one of its officers
and the amount was outstanding as of June 30, 1999. The loan was made pursuant
to a Promissory Note, bears interest at 4.71%, and is repayable in four annual
installments. In addition, the Company has, in conjunction with the 1998
Employee Stock Option Plan, made loans to various of its employees to allow for
the immediate exercise of stock option grants. Each loan was made pursuant to a
full recourse Promissory Note, is secured by a pledge of the shares of stock
which the employee has acquired, bears interest at approximately 5.5% which is
payable quarterly, and is required to be paid in full within five years of the
date of issuance.
NOTE 13. RESEARCH AND DEVELOPMENT CONTRACT
During 1999, the Company entered into a research and development contract
with Sony Corporation ("Sony") to develop a FlashPath product to support Sony's
flash memory card. The Company will manufacture and Sony will distribute the
final product. The contract entitles the Company to receive funds from Sony
over the development period, which is through March 31, 2000, some of which are
conditioned upon Sony's acceptance of deliverables. In accordance with the
terms of the contract, the Company invoices Sony on a monthly basis for
development work. Contract billings are earned based upon achievement of
milestones defined in the contract. Through June 30, 1999, the Company has
invoiced Sony approximately $968,000 for development work, no revenues have
been recognized and approximately $897,000 of contract costs have been charged
to expense. The Company's accounting has been based upon final customer
acceptance being a condition of the Company earning revenue under the contract.
Total estimated contract costs are approximately $1.4 million.
NOTE 14. INITIAL PUBLIC OFFERING
On July 14, 1999, the Company filed a registration statement with the
Securities and Exchange Commission to sell shares of its common stock in an
initial public offering.
F-22
<PAGE>
[INSIDE BACK COVER]
Digital Digital
Cameras Music Players
[Picture of FlashPath: [Picture of floppy
digital camera disk drive with
with arrow arrow pointing to
pointing to FlashPath]
flash memory
card] [Picture of
Easy to Use FlashPath with
[Picture of ----------- arrow pointing to
flash memory Convenient flash memory
card with arrow pointing ----------- card]
to FlashPath] Versatile
[Picture of [Picture of
FlashPath flash memory
with arrow card with
pointing to arrow pointing
floppy disk to digital
drive] music player]
[SmartDisk Logo]
The above pictured flash memory cards and camera are manufactured by third
parties.
<PAGE>
[GRAPHIC OMITTED]
<PAGE>
[GRAPHIC OMITTED]
3,000,000 SHARES
COMMON STOCK
SmartDisk Corporation is offering 3,000,000 shares of its common stock.
This is our initial public offering and no public market currently exists for
our shares. The common stock has been approved for quotation on the Nasdaq
National Market under the symbol "SMDK."
---------------------
INVESTING IN OUR COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 4.
---------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
----------- --------------
<S> <C> <C>
Public Offering Price ........................... $ 13.00 $39,000,000
Underwriting Discounts and Commissions .......... $ 0.91 $ 2,730,000
Proceeds to SmartDisk ........................... $ 12.09 $36,270,000
</TABLE>
THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS
HAVE NOT APPROVED OR DISAPPROVED THESE SECURITIES, OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
We have granted the underwriters a 30-day option to purchase up to an
additional 450,000 shares of common stock to cover over-allotments. BancBoston
Robertson Stephens International Ltd. expects to deliver the shares of common
stock to purchasers on October 12, 1999.
ROBERTSON STEPHENS INTERNATIONAL
HAMBRECHT & QUIST
U.S. BANCORP PIPER JAFFRAY
The date of this prospectus is October 5, 1999.
<PAGE>
UNDERWRITING
The underwriters named below, acting through their representatives,
BancBoston Robertson Stephens Inc., Hambrecht & Quist LLC and U.S. Bancorp
Piper Jaffray Inc., have severally agreed with SmartDisk, subject to the terms
and conditions set forth in the underwriting agreement, to purchase from
SmartDisk the number of shares of common stock set forth opposite their names
below. The underwriters are committed to purchase and pay for all the shares if
any are purchased.
<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
- ------------------------------------------------------------------ ------------
<S> <C>
BancBoston Robertson Stephens Inc. and BancBoston Robertson
Stephens International Ltd. .............................. 1,300,000
Hambrecht & Quist LLC ..................................... 780,000
U.S. Bancorp Piper Jaffray Inc. ........................... 520,000
E*TRADE Securities ........................................ 100,000
First Security Van Kasper ................................. 100,000
First Union Securities, Inc. .............................. 100,000
Suretrade ................................................. 100,000
---------
Total ................................................... 3,000,000
=========
</TABLE>
SmartDisk has been advised by the representatives of the underwriters that
the underwriters propose to offer the shares of common stock to the public at
the initial public offering price set forth on the cover page of this
prospectus and to some dealers at that price less a concession of not in excess
of $0.55 per share, of which $0.10 may be reallowed to other dealers. After the
initial public offering, the public offering price, concession and reallowance
to dealers may be reduced by the representatives. No reduction shall change the
amount of proceeds to be received by SmartDisk as set forth on the cover page
of this prospectus. The common stock is offered by the underwriters, subject to
receipt and acceptance by them and subject to their right to reject any order
in whole or in part.
The underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
OVER-ALLOTMENT OPTION. SmartDisk has granted to the underwriters an
option, exercisable during the 30-day period after the date of this prospectus,
to purchase up to 450,000 additional shares of common stock at the same price
per share as SmartDisk will receive for the 3,000,000 shares that the
underwriters have agreed to purchase. To the extent that the underwriters
exercise this option, each of the underwriters will have a firm commitment to
purchase approximately the same percentage of additional shares that the number
of shares of common stock to be purchased by it shown in the above table
represents as a percentage of the shares offered by this prospectus. If
purchased, the additional shares will be sold by the underwriters on the same
terms as those on which the 3,000,000 shares are being sold. SmartDisk will be
obligated, pursuant to the option, to sell shares to the extent the option is
exercised. The underwriters may exercise the option only to cover
over-allotments made in connection with the sale of the shares of common stock
offered by this prospectus. If the option is exercised in full, the total
public offering price, underwriting discounts and commissions and proceeds to
SmartDisk will be $44,850,000, $3,139,500 and $41,710,500, respectively.
The following table summarizes the compensation and expenses we will pay.
<TABLE>
<CAPTION>
TOTAL
----------------------------------
WITHOUT WITH
PER SHARE OVER-ALLOTMENT OVER-ALLOTMENT
----------- ---------------- ---------------
<S> <C> <C> <C>
Underwriting discounts and commissions paid by us ......... $ 0.91 $2,730,000 $3,139,500
Expenses payable by us .................................... $ -- $1,290,000 $1,290,000
</TABLE>
INDEMNITY. The underwriting agreement contains covenants of indemnity
among the underwriters and SmartDisk against some civil liabilities, including
liabilities under the Securities Act and liabilities arising from breaches of
representations and warranties contained in the underwriting agreement.
60
<PAGE>
LOCK-UP AGREEMENTS. Each of SmartDisk's executive officers, directors,
director-nominees, stock-holders of record and option-holders of record has
agreed with the representatives of the underwriters, for a period of 180 days
after the date of this prospectus, subject to some exceptions, not to offer to
sell, contract to sell, or otherwise sell, dispose of, loan, pledge or grant
any rights with respect to any shares of common stock, any options or warrants
to purchase any shares of common stock, or any securities convertible into or
exchangeable for shares of common stock owned as of the date of this prospectus
or thereafter acquired directly by the holders or with respect to which they
have or hereafter acquire the power of disposition, without the prior written
consent of BancBoston Robertson Stephens Inc. However, BancBoston Robertson
Stephens Inc. may, in its sole discretion and at any time without notice,
release all or any portion of the securities subject to the lock-up agreements.
There are no agreements between the representatives and any of SmartDisk's
stockholders providing consent by the representatives to the sale of shares
prior to the expiration of the lock-up period.
FUTURE SALES. In addition, SmartDisk has agreed that during the lock-up
period SmartDisk will not, without the consent of BancBoston Robertson Stephens
Inc., subject to some exceptions,
/bullet/ consent to the disposition of any shares held by stockholders
subject to lock-up agreements prior to the expiration of the
lock-up period or
/bullet/ issue, sell, contract to sell, or otherwise dispose of, any shares
of common stock, any options to purchase any shares of common
stock or any securities convertible into, exercisable for or
exchangeable for shares of common stock other than SmartDisk's
sale of shares in this offering, the issuance of common stock upon
the exercise of outstanding options, and the issuance of options
or shares under existing stock option and incentive plans provided
those options do not vest, or the right to resell those shares do
not arise until, prior to the expiration of the lock-up period.
LISTING. The common stock has been approved for quotation on the Nasdaq
National Market under the symbol "SMDK."
NO PRIOR PUBLIC MARKET. Prior to this offering, there has been no public
market for the common stock of SmartDisk. Consequently, the initial public
offering price for the common stock offered by this prospectus has been
determined through negotiations between SmartDisk and the representatives of
the underwriters. Among the factors considered in the negotiations were
prevailing market conditions, financial information of SmartDisk, market
valuations of other companies that SmartDisk and the representatives believe to
be comparable to SmartDisk, estimates of the business potential of SmartDisk,
the present state of SmartDisk's development and other factors deemed relevant.
STABILIZATION. The representatives of the underwriters have advised
SmartDisk that some persons participating in this offering may engage in
transactions, including stabilizing bids, syndicate covering transactions or
the imposition of penalty bids, that may have the effect of stabilizing or
maintaining the market price of the common stock at a level above that which
might otherwise prevail in the open market. A "stabilizing bid" is a bid for or
the purchase of the common stock on behalf of the underwriters for the purpose
of fixing or maintaining the price of the common stock. A "syndicate covering
transaction" is the bid for or the purchase of the common stock on behalf of
the underwriters to reduce a short position incurred by the underwriters in
connection with this offering. A "penalty bid" is an arrangement permitting the
representatives to reclaim the selling concession otherwise accruing to an
underwriter or syndicate member in connection with this offering, if the common
stock originally sold by the underwriter or syndicate member is purchased by
the representatives in a syndicate covering transaction and has therefore not
been effectively placed by the underwriter or syndicate member. The
representatives have advised SmartDisk that the transactions may be effected on
the Nasdaq National Market or otherwise and, if commenced, may be discontinued
at any time.
DIRECTED SHARE PROGRAM. At our request, the underwriters have reserved up
to 7.5 percent of the shares of common stock to be issued by SmartDisk and
offered by this prospectus for sale, at the
61
<PAGE>
initial public offering price, to directors, officers, employees, business
associates and related persons of SmartDisk. Those shares will be offered to
the program participants on the same basis as the shares offered to the general
public. The number of shares of common stock available for sale to the general
public will be reduced to the extent that those individuals purchase all or a
portion of these reserved shares. Any reserved shares which are not so
purchased will be offered by the underwriters to the general public on the same
basis as the shares of common stock offered by this prospectus.
LEGAL MATTERS
The validity of the common stock offered by this prospectus will be passed
upon for SmartDisk by Greenberg Traurig, P.A., Miami, Florida. Certain legal
matters in connection with the offering will be passed upon for the
underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation,
Palo Alto, California.
EXPERTS
Ernst & Young LLP, independent certified public accountants, have audited
our consolidated financial statements at December 31, 1997 and 1998 and June
30, 1999 and for each of the three years in the period ended December 31, 1998
and the six months ended June 30, 1999, as set forth in their report. We have
included our financial statements in this prospectus and elsewhere in the
registration statement in reliance on Ernst & Young LLP's report, given on
their authority as experts in accounting and auditing.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission, Washington,
D.C. 20549, a registration statement on Form S-1 under the Securities Act with
respect to the common stock offered by this prospectus. This prospectus does
not contain all of the information set forth in the registration statement and
the exhibits and schedules to the registration statement. For further
information with respect to SmartDisk and the common stock offered by this
prospectus, refer to the registration statement and the exhibits and schedules
filed as a part of the registration statement. Statements contained in this
prospectus concerning the contents of any contract or any other document
referred to are not necessarily complete; refer in each instance to the copy of
the contract or document filed as an exhibit to the registration statement.
Each statement of the type referred to in the preceding sentence is qualified
in all respects by reference to the exhibit. You may inspect a copy of the
registration statement without charge at the Securities and Exchange
Commission's principal office in Washington, D.C. and obtain copies of all or
any part thereof upon payment of a fee from the Public Reference Room of the
Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C.
20549, or at the Securities and Exchange Commission's regional offices in New
York, located at 7 World Trade Center, Suite 1300, New York, New York 10048, or
in Chicago, located at 500 West Madison Street, Suite 1400, Chicago, Illinois
60661. You may obtain information on the operation of the Public Reference Room
by calling the Securities and Exchange Commission at 1-800-SEC-0330. The
Securities and Exchange Commission maintains an Internet site that contains
reports, proxy and information statements and other information regarding
registrants that file electronically with the Securities and Exchange
Commission. The Securities and Exchange Commission's World Wide Web address is
www.sec.gov.
SmartDisk intends to furnish holders of its common stock with annual
reports containing, among other information, audited financial statements
certified by an independent public accounting firm and quarterly reports
containing unaudited condensed financial information for the first three
quarters of each fiscal year. SmartDisk intends to furnish other reports as it
may determine or as may be required by law.
62
