e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM
10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2009
OR
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
COMMISSION FILE NUMBER: 0-29440
SCM MICROSYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE
(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION)
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77-0444317
(I.R.S. EMPLOYER
IDENTIFICATION NUMBER) |
1900 Carnegie Avenue, Building B
Santa Ana, California 92705
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE)
(949) 250-8888
(REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE)
(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer o |
Accelerated filer o |
Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller Reporting Company þ
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
At November 9, 2009, 25,134,985 shares of common stock were outstanding.
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
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2009 |
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2008 |
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2009 |
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2008 |
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Net revenue |
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$ |
13,334 |
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$ |
6,393 |
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$ |
29,450 |
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$ |
19,377 |
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Cost of revenue |
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6,940 |
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3,483 |
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15,371 |
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10,961 |
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Gross profit |
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6,394 |
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2,910 |
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14,079 |
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8,416 |
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Operating expenses: |
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Research and development |
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1,518 |
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980 |
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3,776 |
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3,058 |
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Selling and marketing |
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4,653 |
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2,280 |
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10,635 |
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7,010 |
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General and administrative |
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2,978 |
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1,697 |
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7,665 |
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4,718 |
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Gain on sale of assets |
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(1,168 |
) |
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(1,417 |
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Total operating expenses |
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7,981 |
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4,957 |
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20,659 |
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14,786 |
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Loss from operations |
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(1,587 |
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(2,047 |
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(6,580 |
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(6,370 |
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Loss on equity investments |
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(225 |
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(795 |
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Interest and other income (expense), net |
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(71 |
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(1,117 |
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(5 |
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(293 |
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Loss from continuing operations before income taxes |
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(1,883 |
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(3,164 |
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(7,380 |
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(6,663 |
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Benefit (provision) for income taxes |
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(434 |
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(103 |
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1,307 |
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(151 |
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Loss from continuing operations |
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(2,317 |
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(3,267 |
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(6,073 |
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(6,814 |
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Gain from discontinued operations, net of income taxes |
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39 |
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424 |
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190 |
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273 |
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Gain on sale of discontinued operations, net of income taxes |
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41 |
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44 |
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115 |
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553 |
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Net loss |
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$ |
(2,237 |
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$ |
(2,799 |
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$ |
(5,768 |
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$ |
(5,988 |
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Basic and diluted loss per share from continuing operations |
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$ |
(0.09 |
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$ |
(0.21 |
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$ |
(0.29 |
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$ |
(0.43 |
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Basic and diluted income per share from discontinued operations |
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$ |
0.00 |
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$ |
0.03 |
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$ |
0.01 |
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$ |
0.05 |
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Basic and diluted net loss per share |
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$ |
(0.09 |
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$ |
(0.18 |
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$ |
(0.28 |
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$ |
(0.38 |
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Shares used to compute basic and diluted income (loss) per share |
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25,135 |
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15,744 |
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20,972 |
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15,743 |
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Comprehensive loss: |
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Net loss |
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$ |
(2,237 |
) |
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$ |
(2,799 |
) |
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$ |
(5,768 |
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$ |
(5,988 |
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Unrealized gain on investments |
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28 |
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Foreign currency translation adjustment |
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173 |
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(24 |
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(244 |
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(203 |
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Total comprehensive loss |
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$ |
(2,064 |
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$ |
(2,823 |
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$ |
(6,012 |
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$ |
(6,163 |
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See notes to condensed consolidated financial statements.
3
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
(unaudited)
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September 30, |
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December 31, |
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2009 |
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2008 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
6,162 |
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$ |
20,550 |
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Accounts receivable, net of allowances of $505 and
$689 as of September 30, 2009 and December 31,
2008, respectively |
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9,083 |
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8,665 |
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Inventories |
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6,587 |
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5,065 |
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Income taxes receivable |
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890 |
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Other current assets |
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1,771 |
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1,139 |
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Total current assets |
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24,493 |
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35,419 |
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Equity investments |
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1,449 |
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2,244 |
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Property and equipment, net |
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573 |
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1,236 |
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Intangible assets, net |
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22,738 |
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307 |
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Goodwill |
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21,895 |
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Other assets |
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1,048 |
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1,932 |
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Total assets |
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$ |
72,196 |
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$ |
41,138 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
5,207 |
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$ |
3,555 |
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Liability to related parties |
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1,029 |
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Accrued compensation and related benefits |
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1,847 |
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1,763 |
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Accrued restructuring and other charges |
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1,171 |
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1,576 |
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Accrued professional fees |
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1,457 |
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1,419 |
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Accrued royalties |
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551 |
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475 |
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Accrued sales tax related expenses |
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347 |
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330 |
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Other accrued expenses |
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1,999 |
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1,959 |
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Income taxes payable |
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440 |
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411 |
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Total current liabilities |
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14,048 |
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11,488 |
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Long-term liability to related parties |
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7,959 |
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Deferred tax liability |
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3,585 |
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1,340 |
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Long-term income taxes payable |
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503 |
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184 |
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Commitments and contingencies (see Notes 10 and 11) |
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Stockholders equity: |
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Common stock, $0.001 par value: 40,000 shares
authorized; 25,753 and 16,362 shares issued and
25,135 and 15,744 shares outstanding as of
September 30, 2009 and December 31, 2008,
respectively |
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26 |
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16 |
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Additional paid-in capital |
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253,765 |
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229,788 |
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Treasury stock, 618 shares |
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(2,777 |
) |
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(2,777 |
) |
Accumulated deficit |
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(207,967 |
) |
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(202,199 |
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Accumulated other comprehensive income |
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3,054 |
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3,298 |
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Total stockholders equity |
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46,101 |
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28,126 |
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Total liabilities and stockholders equity |
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$ |
72,196 |
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$ |
41,138 |
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See notes to condensed consolidated financial statements.
4
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
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Nine Months Ended |
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September 30, |
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2009 |
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2008 |
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Cash flows from operating activities: |
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Net loss |
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$ |
(5,768 |
) |
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$ |
(5,988 |
) |
Adjustments to reconcile net loss to net cash used in operating activities: |
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Gain from discontinued operations |
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(305 |
) |
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(826 |
) |
Deferred income taxes |
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(1,986 |
) |
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(2 |
) |
Depreciation and amortization |
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711 |
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216 |
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Gain on disposal of property and equipment |
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(1,264 |
) |
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Stock compensation expense |
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203 |
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|
242 |
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Loss on equity investments |
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|
795 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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2,582 |
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|
2,004 |
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Inventories |
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383 |
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(1,704 |
) |
Other assets |
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104 |
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(352 |
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Income taxes receivable |
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194 |
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Accounts payable |
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(283 |
) |
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(381 |
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Accounts payable to related parties |
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71 |
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Accrued expenses |
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(211 |
) |
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283 |
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Other Liabilities |
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(76 |
) |
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Income taxes payable |
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125 |
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(47 |
) |
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Net cash used in operating activities from continuing operations |
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(4,725 |
) |
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(6,555 |
) |
Net cash used in operating activities from discontinued operations |
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(128 |
) |
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(350 |
) |
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Net cash used in operating activities |
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(4,853 |
) |
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(6,905 |
) |
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Cash flows from investing activities: |
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Capital expenditures |
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(271 |
) |
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(534 |
) |
Cash paid for Hirsch acquisition |
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(14,167 |
) |
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Cash acquired in HIRSCH acquisition |
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3,275 |
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Proceeds from sale of assets, net |
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2,087 |
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Maturities of short-term investments |
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13,873 |
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Net cash provided by (used in) investing activities |
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(9,076 |
) |
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|
13,339 |
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Cash flows from financing activities: |
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Proceeds from issuance of equity securities |
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|
18 |
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Net cash provided by financing activities |
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|
18 |
|
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Effect of exchange rates on cash and cash equivalents |
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(459 |
) |
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|
(32 |
) |
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Net increase (decrease) in cash and cash equivalents |
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|
(14,388 |
) |
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|
6,420 |
|
Cash and cash equivalents at beginning of period |
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|
20,550 |
|
|
|
18,600 |
|
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Cash and cash equivalents at end of period |
|
$ |
6,162 |
|
|
$ |
25,020 |
|
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Supplemental disclosures of cash flow information cash paid for: |
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Income taxes |
|
$ |
246 |
|
|
$ |
175 |
|
|
|
|
|
|
|
|
See notes to condensed consolidated financial statements.
5
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2009
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of America (U.S.
GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and footnotes required by
accounting principles generally accepted in the United States of America for complete financial
statements. In the opinion of management, all adjustments (consisting of normal recurring
adjustments) considered necessary for a fair presentation of SCM Microsystems, Inc.s (SCM or
the Company) financial position, results of operations and cash flows have been included.
Operating results for the three and nine months ended September 30, 2009 are not necessarily
indicative of the results that may be expected for the year ending December 31, 2009 or any future
period. For further information, refer to the financial statements and notes thereto included in
the Companys Annual Report on Form 10-K for the year ended December 31, 2008. The preparation of
unaudited condensed consolidated financial statements necessarily requires the Company to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the condensed consolidated balance sheet dates and the
reported amounts of revenues and expenses for the periods presented.
On April 30, 2009, SCM acquired Hirsch Electronics Corporation (Hirsch), a privately-held
California corporation that designs, engineers, manufactures and markets software, hardware and
services in the security management system/physical access control market. The results for the
acquired Hirsch business are included in the Companys consolidated statements of operations since
the April 30, 2009 acquisition. As a result of the timing of this acquisition, the Companys
condensed consolidated results for the periods presented are not directly comparable.
Discontinued Operations
During 2006, the Company completed the sale of substantially all the assets and some of the
liabilities associated with its Digital Television solutions (DTV solutions) business. During
2003, the Company completed two transactions to sell its retail Digital Media and Video business.
In accordance with the Financial Accounting Standards Board (FASB) Accounting Standards
Codification (ASC) Topic 360-10, Property, Plant and Equipment (ASC 360-10), for the periods
ended September 30, 2009 and 2008, these businesses have been presented as discontinued operations
in the condensed consolidated statements of operations and cash flows and all prior periods have
been reclassified to conform to this presentation. See Note 4 for further discussion of these
transactions.
Recent Accounting Pronouncements and Accounting Changes
In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards
CodificationTM and the Hierarchy of Generally Accepted Accounting Principlesa
replacement of FASB Statement No. 162, (SFAS 168). SFAS 168 replaces SFAS No. 162, The Hierarchy
of Generally Accepted Accounting Principles, and establishes the FASB Accounting Standards
Codification (the Codification) as the source of authoritative accounting principles recognized
by the FASB to be applied by nongovernmental entities in the preparation of financial statements in
conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission
(SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC
registrants. The FASB will no longer issue new standards in the form of Statements, FASB Staff
Positions, or Emerging Issues Task Force Abstracts; instead the FASB will issue Accounting
Standards Updates. Accounting Standards Updates will not be authoritative in their own right as
they will only serve to update the Codification. The issuance of SFAS 168 and the Codification does
not change GAAP. SFAS 168 became effective for SCM for the period ending September 30, 2009.
Management has determined that the adoption of SFAS 168 does not have an impact on the Companys
financial statements.
On January 1, 2009, SCM adopted ASC Topic 805-10, Business Combinations (ASC 805-10). Under
ASC 805-10, an entity is required to recognize the assets acquired, liabilities assumed,
contractual contingencies, and contingent consideration at their fair value on the acquisition
date. It further requires that acquisition-related costs be recognized separately from the
acquisition and expensed as incurred, restructuring costs generally be expensed in periods
subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation
allowances and acquired income tax uncertainties after the measurement
6
period be included in income tax expense. In addition, acquired in-process research and development
is capitalized as an intangible asset and amortized over its estimated useful life. The adoption of
ASC 805-10 changes the Companys accounting treatment for business combinations on a prospective
basis.
On January 1, 2009, SCM adopted ASC Topic 810-10, Consolidation (ASC 810-10). ASC 810-10
changes the accounting and reporting for minority interests, which will be recharacterized as
non-controlling interests and classified as a component of equity. ASC 810-10 is effective for SCM
on a prospective basis for business combinations with an acquisition date beginning in the first
quarter of fiscal year 2009. As of September 30, 2009, SCM did not have any minority interests.
SCM adopted ASC Topic 820-10, Fair Value Measurements and Disclosures (ASC 820-10), as it
relates to nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at
fair value in the financial statements on at least an annual basis, on January 1, 2009 and adopted
ASC 820-10, as it relates to all financial assets and financial liabilities and for all
non-financial assets and non-financial liabilities recognized or disclosed at fair value in the
financial statements on a recurring basis (i.e., at least annually), on January 1, 2008. ASC 820-10
defines fair value, establishes a framework for measuring fair value, and enhances fair value
measurement disclosure. ASC 820-10 does not change the accounting for those instruments that were,
under previous GAAP, accounted for at cost or contract value. The adoption of ASC 820-10 did not
have a significant impact on the Companys consolidated financial statements.
ASC 820-10 establishes a fair value hierarchy that requires an entity to maximize the use of
observable objective inputs and minimize the use of unobservable inputs, which require additional
reliance on the Companys judgment, when measuring fair value. A financial instruments
categorization within the fair value hierarchy is based upon the lowest level of input that is
significant to the fair value measurement. ASC 820-10 establishes three levels of inputs that may
be used to measure fair value:
|
|
|
Level 1 Quoted prices for identical instruments in active markets; |
|
|
|
|
Level 2 Quoted prices for similar instruments in active markets, quoted prices for
identical or similar instruments in markets that are not active and model-derived
valuations, in which all significant inputs are observable in active markets; and |
|
|
|
|
Level 3 Valuations derived from valuation techniques, in which one or more
significant inputs are unobservable. |
The Company uses the following classifications to measure different financial instruments at
fair value, including an indication of the level in the fair value hierarchy in which each
instrument is generally classified:
Cash equivalents include highly liquid debt investments (money market fund deposits,
commercial paper and treasury bills) with maturities of three months or less at the date of
acquisition. These financial instruments are classified in Level 1 of the fair value hierarchy.
Short-term investments consist of corporate notes and United States government agency
instruments and are classified as available-for-sale. These financial instruments are classified in
Level 1 of the fair value hierarchy. As of September 30, 2009, the Company had no short-term
investments.
Assets that are measured and recognized at fair value on a recurring basis classified under
the appropriate level of the fair value hierarchy as of September 30, 2009 and December 31, 2008
were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2009 |
|
December 31, 2008 |
|
|
Level 1 |
|
Level 2 |
|
Level 3 |
|
Total |
|
Level 1 |
|
Level 2 |
|
Level 3 |
|
Total |
Money market fund
deposits |
|
$ |
1,927 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
1,927 |
|
|
$ |
9,426 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
9,426 |
|
Non-financial assets that are measured and recognized at fair value on a non-recurring basis
as of September 30, 2009 are as follows (in thousands); none existed as of December 31, 2008:
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
|
Total |
|
Goodwill |
|
$ |
|
|
|
$ |
|
|
|
$ |
21,895 |
|
|
$ |
21,895 |
|
Acquired intangibles Hirsch Acquisition |
|
|
|
|
|
|
|
|
|
|
22,333 |
|
|
|
22,333 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total: |
|
$ |
|
|
|
$ |
|
|
|
$ |
44,228 |
|
|
$ |
44,228 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The valuation of the acquired intangible assets is classified as a Level 3 measurement,
because it was based on significant unobservable inputs and involved management judgment and
assumptions about market participants and pricing. In determining fair value of the acquired
intangible assets, the Company determined the appropriate unit of measure, the exit market and the
highest and best use for the assets, as per ASC 820-10. The fair value of acquired trade names and
existing technology was determined using relief from royalty approach and the fair value of the
acquired companys customer relationships was determined excess earnings approach. See Note 2 for
discussion of this acquisition. The discount rate used in the valuation of the intangible assets
was derived from a weighted average cost of capital analysis.
As of September 30, 2009 and December 31, 2008, there were no liabilities that are measured
and recognized at fair value on a recurring basis.
2. Acquisition of Hirsch Electronics
In accordance with the Agreement and Plan of Merger entered into on December 10, 2008 (the
Merger Agreement), by and among SCM, Hirsch and two wholly-owned subsidiaries of SCM, on April
30, 2009 (the closing date or the acquisition date) SCM acquired Hirsch through a two-step
merger, pursuant to which Hirsch became Hirsch Electronics LLC, a Delaware limited liability
company and a wholly-owned subsidiary of SCM (the acquisition).
Hirsch sells its products and services in many countries worldwide, through dealers and
systems integrators. The majority of sales are in the United States, followed by Europe and Asia.
Hirsch products are sold in every major industry segment, with the highest number of sales
occurring in market segments requiring a higher-than-average level of security effectiveness, such
as government, critical infrastructure, banking, healthcare and education.
In exchange for all of the outstanding capital stock of Hirsch, SCM paid approximately $14.2
million in cash, issued approximately 9.4 million shares of SCM common stock, and issued warrants
to purchase approximately 4.7 million shares of SCM common stock at an exercise price of $3.00 with
a five-year term, exercisable for two years following the third anniversary of the closing date. In
addition, each warrant to purchase shares of Hirsch common stock outstanding immediately prior to
the effective date of the acquisition was converted into a warrant to purchase the number of shares
of SCM common stock equal to the number of shares of Hirsch common stock that could have been
purchased upon the full exercise of such warrants, multiplied by the conversion ratio of
3.307888, rounded down to the nearest whole share. The per share exercise price for each
converted warrant to purchase SCM common stock was determined by dividing the per share exercise
price of the Hirsch common stock subject to each warrant as in effect immediately prior to the
effective date of the acquisition by the conversion ratio, and rounding that result up to the
nearest cent. The conversion ratio was obtained by dividing the estimated aggregate value of the
acquisition consideration per share of Hirsch common stock, by the 30-day volume weighted average
price of SCMs common stock (as reported on the NASDAQ Stock Market during the 30 days preceding
the day prior to the day of the effective date of the acquisition).
After giving effect to the acquisition of Hirsch, former Hirsch shareholders beneficially own
approximately 37% of the shares of SCM common stock outstanding. Lawrence Midland, a former Hirsch
director and President of the Hirsch subsidiary, joined SCMs Board of Directors on May 1, 2009 and
also became an executive officer of SCM. Douglas Morgan, a former director of Hirsch, also joined
the Board of Directors of SCM immediately following the acquisition. Other than the addition of Mr.
Midland, SCMs executive staff remained unchanged as a result of the acquisition.
The acquisition is accounted for under the acquisition method of accounting under ASC 805-10.
Under this method of accounting, the total purchase consideration is measured at fair value as of
the acquisition date when control is obtained, which for the acquisition of Hirsch was determined
to be April 30, 2009. SCM has obtained a third-party valuation report to calculate the fair value
of the consideration transferred and to measure the identifiable intangible assets acquired and
liabilities to related
parties assumed. The total purchase consideration was determined to be $38.0 million as of the
acquisition date. The following table summarizes the consideration paid for Hirsch and the amounts
of the assets acquired and liabilities assumed at the
8
acquisition date. The fair value of the shares of SCM common stock issued in connection with
the acquisition was determined using the closing price of SCMs common stock as of the acquisition
date of $2.37 per share.
Fair value of consideration transferred (in thousands):
|
|
|
|
|
Cash paid for Hirsch common stock |
|
$ |
14,167 |
|
Fair value of common stock issued |
|
|
22,258 |
|
Fair value of warrants issued |
|
|
1,327 |
|
Fair value of warrants converted |
|
|
200 |
|
|
|
|
|
Total purchase consideration |
|
$ |
37,952 |
|
Purchase price allocation as of April 30, 2009 (in thousands):
|
|
|
|
|
Cash and cash equivalents |
|
$ |
3,275 |
|
Accounts receivable, net |
|
|
2,832 |
|
Inventories |
|
|
1,649 |
|
Other assets |
|
|
437 |
|
Deferred income taxes and taxes receivable |
|
|
1,085 |
|
Property and equipment |
|
|
262 |
|
Amortizable intangible assets: |
|
|
|
|
Developed technology |
|
|
4,600 |
|
Customer relationships |
|
|
10,350 |
|
|
|
|
|
|
Intangible assets with indefinite lives (unamortizable): |
|
|
|
|
Trade names |
|
|
7,800 |
|
|
Accounts payable |
|
|
(1,814 |
) |
Accrued expenses |
|
|
(467 |
) |
Other liabilities |
|
|
(192 |
) |
Deferred tax liabilities and taxes payable |
|
|
(1,957 |
) |
Deferred tax liabilities in connection with acquired tangibles assets with indefinite lives |
|
|
(3,003 |
) |
Fair value of liabilities assumed to related parties |
|
|
(8,800 |
) |
Goodwill |
|
|
21,895 |
|
|
|
|
|
Total purchase consideration |
|
$ |
37,952 |
|
|
|
|
|
As the Company finalizes certain valuation assumptions, adjustments may be recorded in the
related purchase price allocation. There were no changes during the third quarter of 2009.
The identified intangible assets of $22.8 million consist of core technology, trade names and
customer relationships. Developed technology relates to Hirschs current products. Customer
relationships relate to Hirschs ability to sell existing, in-process and future versions of its
products to its existing customers. Trade names represent future value to be derived associated
with the use of existing trade names. SCM expects to amortize developed technology and customer
relationships on a straight-line basis over their expected useful life of 15 years. Assumed
liabilities to related parties are estimated based on contractual payments to be made in future
periods through 2020. The Company has estimated the acquisition date fair value of this liability
to be $8.8 million, based on a discounted cash flow valuation technique.
Of the total purchase consideration, $21.9 million was recognized as goodwill. Goodwill
represents the excess of the purchase consideration of an acquired business over the fair value of
the underlying net assets and liabilities. The goodwill arising from the acquisition is largely
attributable to the synergies expected to be realized after the Companys acquisition and
integration of Hirsch. Hirschs results are included in the Companys reportable segment, Security
and Identity Solutions (formerly called Secure Authentication). None of the goodwill recorded as
part of the Hirsch acquisition will be deductible for United States federal income tax purposes.
Deferred tax assets and liabilities resulting from the acquisition of Hirsch have been netted,
where applicable. As the identified intangible asset trade names has an indefinite life, the
deferred tax liability of $3.0 million relating to the value of the trade names can not be offset
with deferred tax assets with a definite life. Resulting from these procedures, deferred tax
liabilities of $1.7 million after netting with deferred tax assets and $3.0 million deferred tax
liabilities relating to the indefinite life intangible asset have been considered in the purchase
price allocation.
9
Following the acquisition, Hirsch Electronics LLC has become part of the U.S. tax group of the
SCM entities. Accordingly, the deferred tax liability of $1.7 million, as described above, has been
netted with SCMs existing deferred tax assets. The carrying value of SCMs net deferred tax assets
reflects that the Company has been unable to generate sufficient taxable income in certain tax
jurisdictions. A valuation allowance is provided for deferred tax assets if it is more likely than
not these items will either expire before SCM is able to realize their benefit, or that future
deductibility is uncertain. As a result of netting the deferred tax liability of $1.7 million with
SCMs existing deferred tax assets, there is a $1.7 million release of SCMs valuation allowance.
In accordance with ASC 805-10, the release of the valuation allowance was booked as a tax benefit
in the 2009 second quarter financial statements.
Management evaluates the realizability of the deferred tax assets quarterly. At September 30,
2009, SCM has recorded valuation allowances against all of its net deferred tax assets. The
deferred tax assets are still available for SCM to use in the future to offset taxable income,
which would result in the recognition of a tax benefit and a reduction in the effective tax rate.
Actual operating results and the underlying amount and category of income in future years could
render SCMs current assumptions, judgments and estimates of the realizability of deferred tax
assets inaccurate, which could have a material impact on the Companys financial position or
results of operations.
Pro forma financial information:
The results for the acquired Hirsch business are included in the Companys consolidated
statements of operations since the April 30, 2009 date of acquisition. As a result of the timing of
this acquisition, the Companys condensed consolidated results for the periods presented are not
directly comparable. The pro forma financial information is presented for informational purposes
only and is not intended to represent or be indicative of the results of operations that would have
been achieved if the acquisition had been completed as of the date indicated, and should not be
taken as representative of future consolidated results of operations or financial condition of SCM.
The unaudited pro forma financial information in the table below summarizes the combined results of
operations of SCM and Hirsch, as though the acquisition had occurred as of the beginning of the
periods presented. Preparation of the pro forma financial information for all periods presented
required management to make certain judgments and estimates to determine the pro forma adjustments
such as purchase accounting adjustments, which include, among others, cost of sales resulted from
step up of inventory at fair value, amortization charges from acquired intangible assets, and
income tax effects.
Pro forma results of operations for the three and nine months ended September 30, 2009 and
2008 are as follows (in thousands, unaudited):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
13,334 |
|
|
$ |
12,571 |
|
|
$ |
36,110 |
|
|
$ |
37,126 |
|
Net loss |
|
|
(2,237 |
) |
|
|
(4,321 |
) |
|
|
(8,646 |
) |
|
|
(8,659 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
used in
loss per common share basic and diluted |
|
|
25,135 |
|
|
|
25,135 |
|
|
|
25,135 |
|
|
|
25,134 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share basic and diluted |
|
$ |
(0.09 |
) |
|
$ |
(0.17 |
) |
|
$ |
(0.34 |
) |
|
$ |
(0.34 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
3. Stock Based Compensation and Warrants
The Company has a stock-based compensation program that provides its Board of Directors
discretion in creating employee equity incentives. This program includes incentive and
non-statutory stock options under various plans, the majority of which are stockholder approved.
Stock options are generally time-based and expire seven to ten years from the date of grant.
Vesting varies, with some options vesting 25% each year over four years; some vesting
1/12th per month over one year and some vesting 1/12th per month, commencing
four years from the date of grant.
As of September 30, 2009, an aggregate of approximately 2.8 million shares of the Companys
common stock was reserved for future issuance under the Companys stock option plans, of which 2.3
million shares were subject to outstanding options.
10
In calculating stock-based compensation cost, the Company estimates the fair value of each
option grant on the date of grant using the Black-Scholes-Merton options pricing model. The
Black-Scholes-Merton option pricing model was developed for use in estimating the fair value of
traded options that have no vesting restrictions and are fully transferable. In addition, the
Black-Scholes-Merton model requires the input of highly subjective assumptions including the
expected stock price volatility.
The following table illustrates the stock-based compensation expense resulting from stock
options included in the unaudited condensed consolidated statements of operations for the three and
nine months ended September 30, 2009 and 2008 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September. 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenue |
|
$ |
(4 |
) |
|
$ |
6 |
|
|
$ |
9 |
|
|
$ |
16 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development |
|
|
(14 |
) |
|
|
12 |
|
|
|
13 |
|
|
|
36 |
|
Selling and marketing |
|
|
25 |
|
|
|
30 |
|
|
|
99 |
|
|
|
92 |
|
General and administrative |
|
|
5 |
|
|
|
70 |
|
|
|
82 |
|
|
|
98 |
|
|
|
|
|
|
|
|
|
|
Stock-based compensation expense before income taxes |
|
$ |
12 |
|
|
$ |
118 |
|
|
$ |
203 |
|
|
$ |
242 |
|
Income tax benefit |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
Stock-based compensation expense after income taxes |
|
$ |
12 |
|
|
$ |
118 |
|
|
$ |
203 |
|
|
$ |
242 |
|
|
|
|
|
|
|
|
|
|
Stock Option Plans
The Companys Director Option Plan and 1997 Stock Option Plan expired in March 2007, and
options can no longer be granted under these plans. However, outstanding options granted under
these plans remain exercisable in accordance with the terms of the original grant agreements.
In November 2007, stockholders approved the 2007 Stock Option Plan, which authorizes the
issuance of up to 1.5 million shares of the Companys common stock pursuant to stock option grants.
As of September 30, 2009, a total of 582,349 shares of the Companys common stock are reserved for
future option grants under the 2000 Stock Option Plan and the 2007 Stock Option Plan, and 2,260,094
shares were reserved for future issuance pursuant to outstanding options.
In October 2009, stockholders approved an increase of 2.0 million shares to the number of
shares of Common Stock reserved for issuance under the 2007 Stock Option Plan, resulting in an
aggregate of 3.5 million shares.
A summary of the activity under the Companys stock option plans for the nine months ended
September 30, 2009 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
Number of |
|
|
Average |
|
|
Aggregate |
|
|
Remaining |
|
|
|
Available |
|
|
Options |
|
|
Exercise Price |
|
|
Intrinsic |
|
|
Contractual |
|
|
|
for Grant |
|
|
Outstanding |
|
|
per share |
|
|
Value |
|
|
Life (in years) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2008 |
|
|
1,135,219 |
|
|
|
1,836,691 |
|
|
$ |
6.51 |
|
|
$ |
13,652 |
|
|
|
5.62 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options granted |
|
|
(674,077 |
) |
|
|
674,077 |
|
|
$ |
2.39 |
|
|
|
|
|
|
|
|
|
Options cancelled or expired |
|
|
121,207 |
|
|
|
(250,674 |
) |
|
$ |
12.07 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2009 |
|
|
582,349 |
|
|
|
2,260,094 |
|
|
$ |
4.66 |
|
|
$ |
163,714 |
|
|
|
5.61 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested or expected to vest
at September 30, 2009 |
|
|
|
|
|
|
2,043,628 |
|
|
$ |
4.86 |
|
|
$ |
133,911 |
|
|
|
5.53 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at September 30, 2009 |
|
|
|
|
|
|
1,049,785 |
|
|
$ |
6.83 |
|
|
$ |
6,034 |
|
|
|
4.74 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted-average grant date fair value per option for options granted during both the
three and nine months ended September 30, 2009 was $1.55 and $1.35, respectively. The
weighted-average grant date fair value per option for options granted
11
during the three and nine months ended September 30, 2008 was $1.38 and $1.39, respectively.
During the three and nine months ended September 30, 2009, no options were exercised. The total
intrinsic value of options exercised during the three and nine months ended September 30, 2008 was
$0 and $1,500, respectively. Cash proceeds from the exercise of stock options were $0 and $18,000
for the three and nine months ended September 30, 2008, respectively. At September 30, 2009, there
was $1.2 million of unrecognized stock-based compensation expense, net of estimated forfeitures
related to non-vested options, that is expected to be recognized over a weighted-average period of
2.8 years.
The fair value of option grants was estimated by using the Black-Scholes-Merton model with the
following weighted-average assumptions for the three and nine months ended September 30, 2009 and
2008, respectively:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2009 |
|
2008 |
|
2009 |
|
2008 |
|
Expected volatility |
|
|
78 |
% |
|
|
57 |
% |
|
|
73 |
% |
|
|
55 |
% |
Dividend yield |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Risk-free interest rate |
|
|
2.01 |
% |
|
|
2.87 |
% |
|
|
1.80 |
% |
|
|
2.72 |
% |
Expected term (in years) |
|
|
4.00 |
|
|
|
4.00 |
|
|
|
4.00 |
|
|
|
4.00 |
|
Expected Volatility: The Companys computation of expected volatility for the three and nine
months ended September 30, 2009 is based on the historical volatility of the Companys stock for a
time period equivalent to the expected term.
Dividend Yield: The dividend yield assumption is based on the Companys history and
expectation of dividend payouts.
Risk-Free Interest Rate: The risk-free interest rate is based on the U.S. Treasury yield
curve in effect at the time of grant for the expected term of the option.
Expected Term: The Companys expected term represents the period that the Companys
stock-based awards are expected to be outstanding and was determined for the three and nine months
ended September 30, 2009 based on historical experience of similar awards, giving consideration to
the contractual terms of the stock-based awards, vesting schedules and expectations of future
employee behavior.
Forfeitures Rate: Compensation expense recognized in the consolidated statement of operations
for the three and nine months ended September 30, 2009 and 2008 is based on awards ultimately
expected to vest and it reflects estimated forfeitures. ASC Topic 718-10, Compensation-Stock
Compensation, requires forfeitures to be estimated at the time of grant and revised, if necessary,
in subsequent periods if actual forfeitures differ from those estimates.
Warrants
As described in Note 2, as part of the consideration paid by SCM in connection with the
acquisition of Hirsch, SCM issued approximately 4.7 million warrants at an exercise price of $3.00.
In connection with the acquisition, SCM also issued warrants to purchase 205,072 shares of SCM
common stock at exercise prices in the range between $2.42 and $3.03 with a weighted average
exercise price of $2.79, in exchange for outstanding Hirsch warrants.
All warrants will become exercisable for a period of two years on April 30, 2012.
12
4. Discontinued Operations
On May 22, 2006, the Company completed the sale of substantially all the assets and some
of the liabilities associated with its DTV solutions business to Kudelski for a total consideration
of $10.6 million in cash, of which $9.0 million was paid at the time of sale and $1.6 million was
paid in May 2007.
In accordance with ASC 360-10, for the three and nine months ended September 30, 2009 and
2008, the DTV solutions business has been presented as discontinued operations in the consolidated
statements of operations and cash flows and all prior periods have been reclassified to conform to
this presentation.
Based on the carrying value of the assets and the liabilities attributed to the DTV solutions
business on May 22, 2006, and the estimated costs and expenses incurred in connection with the
sale, the Company recorded a net pretax gain of approximately $5.5 million. An additional $1.5
million gain on sale of discontinued operations was realized in May 2007 primarily resulting from
the final payment by Kudelski as described above.
The operating results for the discontinued operations of the DTV solutions business for the
three and nine months ended September 30, 2009 and 2008 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2009 |
|
2008 |
|
2009 |
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating gain (loss) |
|
$ |
(2 |
) |
|
$ |
32 |
|
|
$ |
72 |
|
|
$ |
26 |
|
Net income (loss) before income taxes |
|
$ |
(2 |
) |
|
$ |
32 |
|
|
$ |
87 |
|
|
$ |
26 |
|
Income tax benefit (provision) |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Income (loss) from discontinued operations |
|
$ |
(2 |
) |
|
$ |
32 |
|
|
$ |
87 |
|
|
$ |
26 |
|
During 2003, the Company completed two transactions to sell its retail Digital Media and Video
business. On July 25, 2003, the Company completed the sale of its digital video business to
Pinnacle Systems and on August 1, 2003, the Company completed the sale of its retail digital media
reader business to Zio Corporation. As a result of these sales, the Company has accounted for the
retail Digital Media and Video business as discontinued operations.
The operating results for the discontinued operations of the retail Digital Media and Video
business for the three and nine months ended September 30, 2009 and 2008 are as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2009 |
|
2008 |
|
2009 |
|
2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss |
|
$ |
(73 |
) |
|
$ |
(58 |
) |
|
$ |
(219 |
) |
|
$ |
(202 |
) |
Net gain (loss) before income taxes |
|
$ |
(191 |
) |
|
$ |
365 |
|
|
$ |
(159 |
) |
|
$ |
225 |
|
Income tax benefit |
|
$ |
232 |
|
|
$ |
27 |
|
|
$ |
262 |
|
|
$ |
22 |
|
Gain from discontinued operations |
|
$ |
41 |
|
|
$ |
392 |
|
|
$ |
103 |
|
|
$ |
247 |
|
In April 2008, the Company entered into an agreement to terminate its lease agreement for
premises leased in the UK, which resulted in approximately $0.4 million gain on sale of
discontinued operations in the second quarter of 2008.
13
5. Inventories
Inventories consist of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2009 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
Raw materials |
|
$ |
2,176 |
|
|
$ |
1,648 |
|
Work-in-process |
|
|
578 |
|
|
|
|
|
Finished goods |
|
|
3,833 |
|
|
|
3,417 |
|
|
|
|
|
|
|
|
Total |
|
$ |
6,587 |
|
|
$ |
5,065 |
|
|
|
|
|
|
|
|
6. Equity Investments
Equity investments consist of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
December 31, |
|
|
2009 |
|
2008 |
|
|
|
|
|
|
|
|
|
TranZfinity, Inc. |
|
$ |
1,449 |
|
|
$ |
2,244 |
|
On October 1, 2008, the Company entered into a Stock Purchase Agreement with TranZfinity,
Inc., a privately held Delaware corporation (Tranzfinity), pursuant to which the Company
purchased a 33.7% ownership interest in Tranzfinity for an aggregate purchase price of $2.5
million. This investment is accounted for using the equity method of accounting. During third
quarter 2009, the Companys share in TranZfinity reduced to a 32.4% ownership interest due to
additional shares issued by TranZfinity.
As of the time of the initial investment, the purchase price exceeded SCMs proportionate
share of the assets acquired and liabilities assumed by approximately $1.9 million. The difference
was attributable to intangibles of $0.1 million and equity method goodwill of $1.8 million. The
excess investment relating to intangibles was mainly amortized in 2008 due to the nature of the
intangibles. The equity-method goodwill is not amortized in accordance with ASC Topic 350-10,
Intangibles Goodwill and Other (ASC 350-10); however, it is analyzed for impairment, at least
on an annual basis. In case of adverse circumstances arising which may impact the value of its
investments, the Company also evaluates whether indications for impairment exist on a case by case
basis.
For the three and nine months ended September 30, 2009, the Company recorded a loss of $0.2
million and $0.8 million, respectively, for its share of the losses reported by TranZfinity.
7. Property and Equipment
Property and equipment consists of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2009 |
|
|
2008 |
|
|
|
|
|
|
|
|
|
|
Building and leasehold improvements |
|
$ |
553 |
|
|
$ |
1,734 |
|
Furniture, fixtures and office equipment |
|
|
2,841 |
|
|
|
2,777 |
|
Automobiles |
|
|
28 |
|
|
|
28 |
|
Purchased software |
|
|
3,222 |
|
|
|
3,233 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
6,644 |
|
|
|
7,772 |
|
|
|
|
|
|
|
|
Accumulated depreciation |
|
|
(6,071 |
) |
|
|
(6,536 |
) |
|
|
|
|
|
|
|
Property and equipment, net |
|
$ |
573 |
|
|
$ |
1,236 |
|
|
|
|
|
|
|
|
14
Depreciation expense was $0.1 million and $0.2 million for the three and nine months ended
September 30, 2009, respectively, and $0.1 million and $0.2 million for the three and nine months
ended September 30, 2008, respectively.
The reduction in the amount of building and leasehold improvements resulted from the sale of
the Companys facility in India, which is described in detail in Note 10.
8. Goodwill and Intangible Assets
Goodwill
During the nine months ended September 30, 2009, the Company recorded goodwill of $21.9
million in connection with its acquisition of Hirsch. The goodwill is recorded in the reportable
segment Security and Identity Solutions.
In accordance with ASC 350-10, SCM tests its goodwill and any other intangibles with
indefinite lives annually for impairment and assesses whether there are any indicators of
impairment on an interim basis. Management did not identify any impairment indicators during the
three months ended September 30, 2009.
Intangible Assets Hirsch Acquisition
As discussed in Note 2, during the nine months ended September 30, 2009, SCM acquired other
intangible assets of $22.8 million in connection with the acquisition of Hirsch, of which $15.0
million are related to existing technology and customer relationships and are subject to
amortization, and $7.8 million are related to trade names which are determined to have an
indefinite useful life.
Trade names are not subject to amortization in accordance with ASC 350-10; however, they are
reviewed for impairment on an annual basis, or more frequently if events or changes in
circumstances indicate that the asset might be impaired.
The following table summarizes the gross carrying amount and accumulated amortization for the
intangible assets resulting from the Hirsch acquisition with definite lives:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2009 |
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
Amortization |
|
|
Carrying |
|
|
Accumulated |
|
|
|
|
(in thousands) |
|
Period |
|
|
Value |
|
|
Amortization |
|
|
Net |
|
|
Existing technology |
|
15 years |
|
$ |
4,600 |
|
|
$ |
(130 |
) |
|
$ |
4,470 |
|
Customer relationships |
|
15 years |
|
$ |
10,350 |
|
|
$ |
(287 |
) |
|
$ |
10,063 |
|
|
|
|
|
Totals |
|
|
|
|
|
$ |
14,950 |
|
|
$ |
(417 |
) |
|
$ |
14,533 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
These intangible assets will be amortized over their useful lives. Amortization expense
of these acquired intangible assets for the three months ended September 30, 2009 was $0.2 million,
of which $0.1 million was included in cost of revenue and $0.1 million was included in selling and
marketing expense in the statements of operations. Amortization expense of these acquired
intangible assets for the nine months ended September 30, 2009 was $0.4 million, of which $0.1
million was included in cost of revenue and $0.3 million was included in selling and marketing
expense in the statements of operations.
For the fourth quarter of 2009, amortization expenses for the intangible assets resulting from
the Hirsch acquisition are expected to be $0.3 million. Amortization expenses of $1.0 million per
year are expected for the years 2010 through 2023, and $0.3 million is expected for 2024.
Intangible Assets TranZfinity
The Company entered into an Exclusive Cooperation Agreement on April 17, 2008 with TranZfinity
(the Cooperation Agreement), which was amended in July 2009. Under the terms of the Cooperation
Agreement, TranZfinity works with the Company to develop modular USB devices for the Companys
product portfolio and will supply the Companys customers with TranZfinitys application software
and services supporting those devices. Pursuant to the Cooperation Agreement, the Company is
obligated to pay TranZfinity an exclusivity fee of up to $0.8 million for the right to be the
exclusive provider of those products,
15
of which $0.3 million was paid in the fourth quarter of 2008
and $0.2 million was paid in the first quarter of 2009. The Company is recording amortization
expense based on the estimated useful life.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2009 |
|
December 31, 2008 |
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
|
|
|
Gross |
|
|
|
|
|
|
Amortization |
|
Carrying |
|
Accumulated |
|
|
|
|
|
Carrying |
|
Accumulated |
|
|
(in thousands) |
|
Period |
|
Value |
|
Amortization |
|
Net |
|
Value |
|
Amortization |
|
Net |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exclusivity right |
|
54 months |
|
$ |
500 |
|
|
$ |
(95 |
) |
|
$ |
405 |
|
|
$ |
321 |
|
|
$ |
(14 |
) |
|
$ |
307 |
|
In accordance with ASC 350-10, SCMs intangible assets TranZfinity are subject to
amortization. SCM evaluates long-lived assets under ASC 360-10.
Amortization expense related to these intangible assets was $29,000 and $0.1 million for the
three and nine months ended September 30, 2009, respectively, and zero for the three and nine
months ended September 30, 2008, respectively, and was included in the cost of revenue in the
statements of operations.
Estimated future amortization of intangible assets TranZfinity is as follows (in thousands):
|
|
|
|
|
Fiscal Year |
|
Amount |
|
2009 |
|
$ |
28 |
|
2010 |
|
|
114 |
|
2011 |
|
|
114 |
|
2012 |
|
|
114 |
|
2013 |
|
|
35 |
|
|
|
|
|
Total |
|
$ |
405 |
|
|
|
|
|
9. Restructuring and Other Charges
Discontinued Operations
During the three and nine months ended September 30, 2009, income from restructuring and other
items related to discontinued operations was approximately $41,000 and $0.1 million, respectively.
During the three and nine months ended September 30, 2008, income from restructuring and other
items related to discontinued operations was approximately $46,000 and $0.6 million, respectively.
In the second quarter of 2008, a termination payment and related transaction costs of approximately
$0.5 million were incurred and the related restructuring accruals of approximately $0.9 million
were released related primarily to an agreement to terminate our lease agreement for the premises
leased in the UK. The transaction resulted in a net gain of approximately $0.4 million from
discontinued operations in the second quarter of 2008.
16
Accrued liabilities related to the Digital Media and Video restructuring actions and other
activities during the nine months ended September 30, 2009 and during the year ended December 31,
2008 consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease/Contract |
|
|
|
|
|
|
|
|
|
Commitments |
|
|
Other Costs |
|
|
Total |
|
Balances as of January 1, 2008 |
|
$ |
2,589 |
|
|
$ |
349 |
|
|
$ |
2,938 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
(594 |
) |
|
|
|
|
|
|
(594 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(594 |
) |
|
|
|
|
|
|
(594 |
) |
Payments and other changes in 2008 |
|
|
(765 |
) |
|
|
(19 |
) |
|
|
(784 |
) |
|
|
|
|
|
|
|
|
|
|
Balances as of December 31, 2008 |
|
|
1,230 |
|
|
|
330 |
|
|
|
1,560 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for Q1 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
(37 |
) |
|
|
|
|
|
|
(37 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(37 |
) |
|
|
|
|
|
|
(37 |
) |
Payments and other changes in Q1 2009 |
|
|
(98 |
) |
|
|
(16 |
) |
|
|
(114 |
) |
|
|
|
|
|
|
|
|
|
|
Balances as of March 31, 2009 |
|
|
1,095 |
|
|
|
314 |
|
|
|
1,409 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for Q2 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
(38 |
) |
|
|
|
|
|
|
(38 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(38 |
) |
|
|
|
|
|
|
(38 |
) |
Payments and other changes in Q2 2009 |
|
|
(98 |
) |
|
|
18 |
|
|
|
(80 |
) |
|
|
|
|
|
|
|
|
|
|
Balances as of June 30, 2009 |
|
|
959 |
|
|
|
332 |
|
|
|
1,291 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for Q3 2009 |
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
(41 |
) |
|
|
|
|
|
|
(41 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(41 |
) |
|
|
|
|
|
|
(41 |
) |
Payments and other changes in Q3 2009 |
|
|
(98 |
) |
|
|
15 |
|
|
|
(83 |
) |
|
|
|
|
|
|
|
|
|
|
Balances as of September 30, 2009 |
|
$ |
820 |
|
|
$ |
347 |
|
|
$ |
1,167 |
|
|
|
|
|
|
|
|
|
|
|
Continuing Operations
Restructuring accruals from continuing operations were $4,000 and $16,000 as of September 30,
2009 and December 31, 2008, respectively.
10. Gain on Sale of Assets
In September 2009, the Company sold its facility in India for cash of $1.8 million and
recognized a pre-tax gain of $1.2 million on the transaction.
In March 2009, the Company sold at auction certain non-strategic patents that are unrelated to
its current business, for cash of $0.2 million, net of costs, and recognized a pre-tax gain of $0.2
million on the transaction.
11. Segment Reporting, Geographic Information and Major Customers
ASC 280-10, Segment Reporting, establishes standards for the reporting by public business
enterprises of information about operating segments, products and services, geographic areas, and
major customers. The method for determining what information to report is based on the way that
management organizes the operating segments within the Company for making operating decisions and
assessing financial performance. The Companys chief operating decision makers are considered to be
its executive staff, consisting of the Chief Executive Officer; Chief Financial Officer; Executive
Vice President, Strategic Sales and Business Development; and President, Hirsch subsidiary.
17
The Companys continuing operations provide secure security and identity solutions in two
primary market segments: Security and Identity Solutions (formerly called Secure Authentication)
and Digital Media and Connectivity. The acquired Hirsch business has been included in the segment
Security and Identity Solutions. The executive staff reviews financial information and business
performance along these two business segments. The Company evaluates the performance of its
segments at the revenue and gross margin level. The Companys reporting systems do not track or
allocate operating expenses or assets by segment. The Company does not include intercompany
transfers between these two business segments for the purpose of assessing financial performance.
Summary information by segment for the three and nine months ended September 30, 2009 and 2008
is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
Security and Identity Solutions: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue |
|
$ |
12,508 |
|
|
$ |
5,873 |
|
|
$ |
26,479 |
|
|
$ |
15,758 |
|
Gross profit |
|
|
6,069 |
|
|
|
2,748 |
|
|
|
12,999 |
|
|
|
7,172 |
|
Gross profit % |
|
|
49 |
% |
|
|
47 |
% |
|
|
49 |
% |
|
|
46 |
% |
|
Digital Media and Connectivity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue |
|
$ |
826 |
|
|
$ |
520 |
|
|
$ |
2,971 |
|
|
$ |
3,619 |
|
Gross profit |
|
|
325 |
|
|
|
162 |
|
|
|
1,080 |
|
|
|
1,244 |
|
Gross profit % |
|
|
39 |
% |
|
|
31 |
% |
|
|
36 |
% |
|
|
34 |
% |
|
Total: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue |
|
$ |
13,334 |
|
|
$ |
6,393 |
|
|
$ |
29,450 |
|
|
$ |
19,377 |
|
Gross profit |
|
|
6,394 |
|
|
|
2,910 |
|
|
|
14,079 |
|
|
|
8,416 |
|
Gross profit % |
|
|
48 |
% |
|
|
46 |
% |
|
|
48 |
% |
|
|
43 |
% |
Geographic net revenue is based on selling location. Information regarding net revenue by
geographic region is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
Net revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
$ |
8,865 |
|
|
$ |
2,655 |
|
|
$ |
17,517 |
|
|
$ |
7,214 |
|
Europe |
|
|
2,903 |
|
|
|
2,064 |
|
|
|
7,544 |
|
|
|
7,151 |
|
Asia-Pacific |
|
|
1,566 |
|
|
|
1,674 |
|
|
|
4,389 |
|
|
|
5,012 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
13,334 |
|
|
$ |
6,393 |
|
|
$ |
29,450 |
|
|
$ |
19,377 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% of net revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
|
66 |
% |
|
|
42 |
% |
|
|
59 |
% |
|
|
37 |
% |
Europe |
|
|
22 |
% |
|
|
32 |
% |
|
|
26 |
% |
|
|
37 |
% |
Asia-Pacific |
|
|
12 |
% |
|
|
26 |
% |
|
|
15 |
% |
|
|
26 |
% |
18
Long-lived assets by geographic location as of September 30, 2009 and December 31, 2008, are
as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2009 |
|
|
2008 |
|
Property and equipment, net: |
|
|
|
|
|
|
|
|
United States |
|
$ |
251 |
|
|
$ |
5 |
|
Europe |
|
|
254 |
|
|
|
259 |
|
Asia-Pacific |
|
|
68 |
|
|
|
972 |
|
|
|
|
|
|
|
|
|
Total |
|
$ |
573 |
|
|
$ |
1,236 |
|
|
|
|
|
|
|
|
The reduction in property and equipment, net results from the sale of the Companys facility
in India, which is described in detail in Note 10.
12. Commitments
The Company leases its facilities, certain equipment, and automobiles under noncancelable
operating lease agreements. Those lease agreements existing as of September 30, 2009 expire at
various dates during the next five years.
Purchases for inventories are highly dependent upon forecasts of customer demand. Due to the
uncertainty in demand from its customers, the Company may have to change, reschedule, or cancel
purchases or purchase orders from its suppliers. These changes may lead to vendor cancellation
charges on these purchases or contractual commitments. As of September 30, 2009, purchase and
contractual commitments due within one year were approximately $11.5 million, and additional
purchase and contractual commitments due within two years were approximately $1.0 million.
SCM provides warranties on certain product sales, which range from twelve to twenty-four
months, and allowances for estimated warranty costs are recorded during the period of sale. The
determination of such allowances requires the Company to make estimates of product return rates and
expected costs to repair or to replace the products under warranty. SCM currently establishes
warranty reserves based on historical warranty costs for each product line combined with liability
estimates based on the prior twelve months sales activities. If actual return rates and/or repair
and replacement costs differ significantly from SCMs estimates, adjustments to recognize
additional cost of sales may be required in future periods. As of September 30, 2009, no material
accruals for warranties were recorded.
13. Net Income (Loss) per Common Share
The following table sets forth the computation of basic and diluted net income (loss) per
common share (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
For the Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2009 |
|
|
2008 |
|
|
2009 |
|
|
2008 |
|
|
Net loss from continuing operations |
|
$ |
(2,317 |
) |
|
$ |
(3,267 |
) |
|
$ |
(6,073 |
) |
|
$ |
(6,814 |
) |
Income (loss) from discontinued operations |
|
|
80 |
|
|
|
468 |
|
|
|
305 |
|
|
|
826 |
|
Net loss |
|
$ |
(2,237 |
) |
|
$ |
(2,799 |
) |
|
$ |
(5,768 |
) |
|
$ |
(5,988 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in income (loss) per common
share basic |
|
|
25,135 |
|
|
|
15,744 |
|
|
|
20,972 |
|
|
|
15,743 |
|
Net income (loss) per common share basic
and diluted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operations |
|
$ |
(0.09 |
) |
|
$ |
(0.21 |
) |
|
$ |
(0.29 |
) |
|
$ |
(0.43 |
) |
Discontinued operations |
|
$ |
0.00 |
|
|
$ |
0.03 |
|
|
$ |
0.01 |
|
|
$ |
0.05 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share basic and diluted |
|
$ |
(0.09 |
) |
|
$ |
(0.18 |
) |
|
$ |
(0.28 |
) |
|
$ |
(0.38 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
19
The computation of diluted net income per common share for the three and nine months ended
September 30, 2009 excludes the effect of the potential exercise of options to purchase
approximately 1,000 and 2,000 shares, respectively, because the effect would be anti-dilutive in
periods when there is a net loss. The computation of diluted net income per common share for the
three and nine months ended September 30, 2009 also excludes the effect of the potential exercise
of options to purchase approximately 2.3 million and 2.0 million shares of common stock,
respectively, because the option exercise price was greater than the average market price of the
shares and the effect would have been anti-dilutive.
The computation of diluted net loss per common share for the three and nine months ended
September 30, 2008 excludes the effect of the potential exercise of options to purchase
approximately zero and 3,000 shares, respectively, because the effect would be anti-dilutive in
periods when there is a net loss. The computation of diluted net loss per common share for the
three and nine months ended September 30, 2008 also excludes the effect of the potential exercise
of options to purchase approximately 2.0 million and 1.9 million shares, respectively, because the
option exercise price was greater than the average market price of the common shares and the effect
would have been anti-dilutive.
14. Related Party Transactions
Prior to the acquisition of Hirsch by SCM, effective November 1994 Hirsch had entered into a
settlement agreement (the 1994 Settlement Agreement) with two limited partnerships, Secure
Keyboards, Ltd. (Secure Keyboards) and Secure Networks, Ltd. (Secure Networks). Under the terms
of a previous agreement, Hirsch had purchased the exclusive rights to certain patents and
technology from Secure Keyboards and Secure Networks.
Secure Keyboards and Secure Networks were related to Hirsch through certain common
shareholders and limited partners, including Hirschs President Lawrence Midland, who is now an
Executive Vice President and director of SCM. Following the acquisition, Mr. Midland continues to
own 30% of Secure Keyboards and 9% of Secure Networks.
On April 8, 2009, Secure Keyboards, Secure Networks and Hirsch amended and restated the 1994
Settlement Agreement to replace the royalty-based payment arrangement under the 1994 Settlement
Agreement with a new, definitive installment payment schedule with contractual payments to be made
in future periods through 2020 (the 2009 Settlement Agreement ). Hirschs initial annual payment
to Secure Keyboards and Secure Networks under the 2009 Settlement Agreement for the period from
January 1, 2009 through December 31, 2009 will be $986,000, with subsequent annual payments subject
to increase based on the percentage increase in the Consumer Price Index during the prior calendar
year.
The final payment to Secure Networks is due on January 30, 2012 and the final payment to
Secure Keyboards is due on January 30, 2021. Hirschs payment obligations under the 2009 Settlement
Agreement will continue through the calendar year period ending December 31, 2020, unless Hirsch
elects at any time on or after January 1, 2012 to earlier satisfy its obligations by making a
lump-sum payment to Secure Keyboards. The amount of the lump-sum payment will be based on an
assumed growth rate of the remaining annual payments of 4%, in lieu of the percentage increase in
the Consumer Price Index, and a discount rate of 9%.
Prior to the acquisition of Hirsch by SCM, SCM was not a party to the 2009 Settlement
Agreement. SCM has, however, provided Secure Keyboards and Secure Networks with a limited guarantee
of Hirschs payment obligations under the 2009 Settlement Agreement (the Guarantee). The 2009
Settlement Agreement and the Guarantee became effective upon the acquisition of Hirsch on April 30,
2009.
During the period from April 30, 2009 to September 30, 2009, $0.3 million expense was
recognized by SCM in its statement of operations for the interest accreted on the discounted
liability amount.
On September 21, 2009, SCM announced it had entered into a business combination agreement
with Bluehill ID AG, a Swiss industrial holding group (Bluehill ID) focused on investments in the
radio frequency identification (RFID)/identification and security industries, pursuant to which the
Company will make an offer to the Bluehill ID shareholders to acquire all of the Bluehill ID shares
in exchange for shares of SCM common stock. As of November 9, 2009, Lincoln Vale European Partners
(Lincoln Vale) beneficially owned and had the right to vote approximately 6.1% of the outstanding
shares of SCM common stock, and approximately 9.8% of the outstanding bearer shares in Bluehill ID.
Upon the closing of the offer to Bluehill ID shareholders, it is anticipated that Lincoln Vale will
beneficially own approximately 7.8% of the outstanding shares of SCM
20
common stock. Dr. Hans Liebler, one of SCMs directors, is a partner of Lincoln Vale and may
be deemed to beneficially own, either directly or indirectly through limited partnerships, the
shares beneficially owned by Lincoln Vale.
As of November 9, 2009, Bluehill ID beneficially owned and had the right to vote 1,201,004
shares of SCM common stock and Ayman Ashour, Bluehill IDs CEO and President of its board of
directors, beneficially owned 104,000 shares, and Bluehill ID and Mr. Ashour, collectively,
beneficially owned approximately 5.2% of the currently outstanding shares of SCM common stock.
Upon the closing of the offer to Bluehill ID shareholders, it is anticipated that Mr. Ashour will
be appointed to serve as executive chairman of SCMs Board of Directors.
15. Legal Proceedings
From time to time, the Company could become subject to claims arising in the ordinary course
of business or be named as a defendant in lawsuits. While the outcome of such claims or other
proceedings cannot be predicted with certainty, the Companys management expects that any such
liabilities, to the extent not provided for by insurance or otherwise, will not have a material
adverse effect on the Companys financial condition, results of operations or cash flows.
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements for purposes of the
safe harbor provisions under Section 27A of the Securities Act of 1933, as amended, and Section 21E
of the Securities Exchange Act of 1934, as amended. For example, statements, other than statements
of historical facts regarding our strategy, future operations, financial position, projected
results, estimated revenues or losses, projected costs, prospects, plans, market trends,
competition and objectives of management constitute forward-looking statements. In some cases, you
can identify forward-looking statements by terms such as will, believe, could, should,
would, may, anticipate, intend, plan, estimate, expect, project or the negative of
these terms or other similar expressions. Although we believe that our expectations reflected in or
suggested by the forward-looking statements that we make in this Quarterly Report on Form 10-Q are
reasonable, we cannot guarantee future results, performance or achievements. You should not place
undue reliance on these forward-looking statements. All forward-looking statements speak only as of
the date of this Quarterly Report on Form 10-Q. While we may elect to update forward-looking
statements at some point in the future, we specifically disclaim any obligation to do so, even if
our expectations change, whether as a result of new information, future events or otherwise. We
also caution you that such forward-looking statements are subject to risks, uncertainties and other
factors, not all of which are known to us or within our control, and that actual events or results
may differ materially from those indicated by these forward-looking statements. We disclose some of
the important factors that could cause our actual results to differ materially from our
expectations under Part II Item 1A, Risk Factors and elsewhere in this Quarterly Report on Form
10-Q. These cautionary statements qualify all of the forward-looking statements included in this
Quarterly Report on Form 10-Q that are attributable to us or persons acting on our behalf.
The following information should be read in conjunction with the unaudited condensed
consolidated financial statements and notes thereto set forth in Part I Item 1 of this Quarterly
Report on Form 10-Q. We also urge readers to review and consider our disclosures describing
various factors that could affect our business, including the disclosures under the headings
Managements Discussion and Analysis of Financial Condition and Results of Operations and Risk
Factors and the audited financial statements and notes thereto contained in our Annual Report on
Form 10-K for the year ended December 31, 2008.
The terms SCM, the Company, we and us refer to SCM Microsystems, Inc. and its
subsidiaries, unless otherwise specified.
21
Overview
Highlights of the Third Quarter, Ending September 30, 2009:
|
|
|
Financial results for the 2009 third quarter include the results of the Hirsch business,
which we acquired on April 30, 2009 and consolidated as a wholly-owned subsidiary. |
|
|
|
|
Net revenue rose to $13.3 million in the third quarter of 2009, a substantial increase
compared to the same quarter a year earlier due primarily to new revenue from Hirsch.
Excluding Hirsch, revenues were relatively unchanged from the previous year. |
|
|
|
|
On a continuing basis, SCM overall posted an after-tax loss of $(2.3) million in the
third quarter of 2009 compared to a loss of $(3.3) million in the same quarter of the
previous year. Our net loss for the third quarter of 2009 was $(2.2) million, compared to a
loss of $(2.8) million in the third quarter of 2008. |
|
|
|
|
On September 21, 2009, we announced that we have entered into a business combination
agreement with Bluehill ID AG, a Swiss industrial holding group focused on investments in
the radio frequency identification (RFID)/identification and security industries. We
currently expect the transaction to close in early 2010. |
Narrative Summary of the 2009 Third Quarter
During the third quarter of 2009, we continued our integration of the Hirsch business and
completed the closure of our Fremont, California office and the move of our U.S. headquarters to
Hirschs headquarters in Santa Ana, California. Our focus in the integration has been on creating
synergies within our sales and marketing organizations to accelerate the acquisition of new
customers, expand our mutual distribution channels and introduce new products in target markets.
With the addition of revenues from Hirsch, net revenue increased 109% in the third quarter of
2009 compared with the third quarter of 2008. Excluding Hirsch, revenues were relatively unchanged
from the previous year. Sales of our smart card reader products in the U.S. and Asia remained relatively strong and rose sequentially in the third quarter of 2009, but were
lower compared with the same quarter of the previous year. Sales of smart card reader products were
higher year over year in Europe and benefitted from a large order
for an ID project in Spain. At the same time, sales of our eHealth terminals for the electronic
healthcard program in Germany were lower than expected, due to slow adoption within the initial
test region and the transition in administration following the countrys recent national elections.
Our overall gross margin rose to 48% in the 2009 third quarter from 46% in the same quarter of
2008, as our revenue mix improved due to inclusion of higher-margin products from Hirsch as well as
in our Digital Media and Connectivity business. At the same time, operating expenses were 61%
higher in the third quarter of 2009 compared with the third quarter of 2008, primarily due to the
inclusion of operating expenses relating to the Hirsch business, as well as $0.8 million in
transaction expenses related to our proposed acquisition of Bluehill ID and $0.5 million in
severance costs for our former CFO, Stephan Rohaly, offset by a $1.2 million pre-tax gain on the
sale of our office building in India. Excluding the incremental expenses relating to the Hirsch
business and the one-time expenses and credits described above, operating expenses decreased year
over year and were flat with the previous quarter. We posted an after-tax loss of $(2.3) million
from continuing operations in the third quarter of 2009, compared to a loss of $(3.3) million in
the third quarter of 2008. Our net loss for the quarter was $(2.2) million, compared to $(2.8)
million in the same quarter of the prior year.
Cash and cash equivalents were $6.2 million at the end of the 2009 third quarter, up $0.9
million from $5.3 million at the end of the second quarter of 2009. The increase in cash in the
third quarter primarily resulted from the gain on the sale of our office building in India during
the quarter.
22
Company Background
SCM is a global provider of security and identity solutions for secure access, secure identity
and secure exchange. For organizations and individuals that need to secure their digital assets,
electronic transactions and facilities, SCM provides solutions that cut costs and reduce risk and
liabilities. Instead of providing only a piece of the puzzle, our offerings are broad and
integrated, enabling complete solutions that allow customers to turn to a single source to meet all
their security and identity management challenges. We were incorporated in 1996 under the laws of
the state of Delaware.
SCMs products are installed in every major industry segment and around the world. Our
solutions are especially sought after in market segments requiring a higher-than-average level of
security effectiveness, such as government, public utilities and other critical infrastructure,
data centers, healthcare, education, communications, finance, transportation and manufacturing, as
well as by security-conscious individuals. Our distribution partners and customers include top-tier
computer manufacturers, OEMs, smart card manufacturers, security application providers,
distributors, system integrators, specialized resellers and VARs, financial institutions,
enterprises and government agencies.
We sell our security and identity solutions in two primary market segments: Security and
Identity Solutions (formerly called Secure Authentication) and Digital Media and Connectivity.
|
|
|
For the Security and Identity Solutions market, we offer a broad range of contact,
contactless and mobile smart card reader technology, access control products and digital
identity and transaction platforms, as well as systems that integrate physical access
control, secure data storage and transmission, digital certificates, biometrics and digital
video. Our solutions are used in a wide variety of industries for security, identity,
contactless payment, e-health and electronic government services. We also offer a range of
smart card-based productivity solutions, which include readers and software, for small and
medium-size businesses under our CHIPDRIVE® brand. |
|
|
|
|
For the Digital Media and Connectivity market, we offer commercial digital media readers
that are used in digital photo kiosks to transfer digital content to and from various flash
media. |
SCMs shares are traded on the NASDAQ exchange in the U.S. (symbol: SCMM) and the regulated
market (Prime Standard) of the Frankfurt Stock Exchange in Germany (symbol: SMY).
Recent Trends and Strategies for Growth
We have adopted a multi-pronged strategy for growth that includes efforts to expand and
diversify our customer base, fully capture emerging market opportunities and accelerate long-term
growth. A primary component of our strategy is the development of a range of new contactless and
near field communication (NFC) infrastructure products to enable fast growing contactless
applications and services for the electronic transaction market (including payment and ticketing),
government and enterprise customers. Additionally, we are developing and implementing programs to
market our existing product offerings into new distribution channels and new geographic regions.
The worldwide recession has slowed our progress in penetrating new markets; however, we continue to
have a high level of activity to develop new customers.
As part of our growth strategy, we have adopted a more active approach to partnering with
other companies that can provide complementary resources and strengths. For example, in April
2008, we began working with TranZfinity, a provider of e-payment transactions solutions, to develop
our @MAXX® family of contactless readers and to provide application services for those readers. On
October 1, 2008, we entered into a Stock Purchase Agreement with TranZfinity, pursuant to which we
purchased 10 million shares of TranZfinity common stock, or 33.7% of TranZfinitys outstanding
shares (16.67% on a fully diluted basis), for an aggregate purchase price of $2.5 million. The
transaction closed on October 2, 2008. We also entered into a Stockholders Agreement with
TranZfinity and certain other stockholders of TranZfinity, which sets forth certain rights and
privileges of SCM and the other stockholders of TranZfinity, including rights and privileges with
respect to the composition of TranZfinitys board of directors.
An additional component of our growth strategy is to actively seek merger and acquisition
opportunities to expand our business, reinforce our market position in targeted areas and fully
leverage our strengths and opportunities, such as the acquisition of Hirsch, which was completed
during the second quarter of 2009. We believe our acquisition of Hirsch supported our growth
strategy, as it nearly doubled our revenues, helped further diversify our customer base and
positioned our company to better
address the growing market demand for solutions that address both IT security and physical
access, a trend referred to in the security industry as convergence. During the third quarter of
2009, we announced our intention to acquire Bluehill ID, a Swiss
23
industrial holding group focused on investments in the RFID/identification and security industries.
We believe that combining with Bluehill ID will allow us to accelerate our development of a
leadership position in contactless markets and technology and will further diversify our business
geographically.
On April 30, 2009, we completed our acquisition of Hirsch, a private California corporation
that manufactures and sells physical access control and other security management systems.
Following the acquisition, Hirsch became a Delaware limited liability company and wholly-owned
subsidiary of SCM. In exchange for all of the outstanding capital stock of Hirsch, we paid
approximately $14.2 million in cash, issued approximately 9.4 million shares of SCM common stock
and issued warrants to purchase approximately 4.7 million shares of SCM common stock as
consideration in connection with the Hirsch acquisition. Further details of the acquisition are
described in Note 2 to the financial statements included in this Quarterly Report on Form 10-Q.
Following the acquisition, former Hirsch shareholders beneficially own approximately 37% of the
shares of SCM common stock outstanding. Upon the closing of the acquisition, Lawrence Midland, a
former Hirsch director and current President of Hirsch, joined SCMs Board of Directors and became
an Executive Vice President of SCM. Douglas Morgan, a former director of Hirsch, also joined the
Board of Directors of SCM.
As a result of our April 30, 2009 acquisition of Hirsch, Hirschs operating results have been
included in our consolidated results since April 30, 2009, and will continue to be included in our
consolidated results going forward.
Upon the closing of the offer to the Bluehill ID shareholders, it is currently anticipated
that we will increase the size of our Board of Directors from seven to nine directors, and include
three appointees of Bluehill ID Ayman S. Ashour, Dr. Cornelius Boersch and Daniel S. Wenzel
who are expected to be appointed to our Board of Directors as of the closing of the offer, with Mr.
Ashour serving as Executive Chairman of our Board of Directors. Werner Koepf, the current Chairman
of our Board of Directors, is expected to resign upon the closing of the offer. Effective September
30, 2009, Stephan Rohaly resigned from his position as our Vice President Finance, Chief Financial
Officer and Secretary, and Martin Wimmer was appointed by our Board of Directors to serve as
interim Chief Financial Officer, in addition to retaining his current position of Vice President
Finance, until a new Chief Financial Officer is named.
Trends in our Business
Sales Trends
The ongoing global recession and economic uncertainty has created a broader cautionary
environment for us and for our customers and has resulted in decreased or delayed orders for our
products across geographic markets. We believe sales to some markets will continue to be
constricted until the global economic environment strengthens, end user demand increases and the
lending environment for capital purchases improves. Despite the continued sluggishness of security
and identity programs during the third quarter of 2009, our revenue increased 109% compared to the
third quarter of 2008, primarily as a result of our acquisition of Hirsch and investments made in
key markets and regions.
We believe that our acquisition of Hirsch has strengthened our performance across multiple
financial metrics, our ability to capture new and existing sales opportunities and our overall
business profile. As a result of the inclusion of Hirsch operating results, sales more than doubled
in our Security and Identity Solutions business and overall gross profit margin increased by two
percentage points in the third quarter of 2009 compared with the third quarter of 2008. The
integration of Hirsch and SCM is proceeding as planned: sales and marketing cross training has been
completed; integrated finance systems, including reporting processes, are in place or in process;
and we have completed the move of our U.S. headquarters to Hirschs Santa Ana, California
headquarters and the subsequent closure of our Fremont, California facility.
In the U.S. government market, sales of our smart card reader products for PC and network
access by military and federal employees has been an important component of our overall revenue
composition. In addition to normal variability in demand quarter to quarter, in recent periods,
project and budget delays in the U.S. government sector and the rapid shift towards lower cost
embedded chips rather than external smart card readers by laptop and keyboard manufacturers
servicing the U.S. government sector have constricted our sales in this market. The U.S. government
sector is also an important market for our Hirsch business, but Hirschs sales model is more
focused on the provision of integrated systems, rather than point solutions, and is generally less
susceptible to variability from project delays and other factors. In the 2009 third quarter, sales
from the Hirsch business were up
compared with the third quarter of 2008, and a significant percentage of Hirsch sales related
to projects at federal government agencies. We believe that our acquisition of Hirsch creates a
substantially more stable and consistent revenue profile for SCM in
24
the U.S. government sector, given Hirschs sales model. We further believe that Hirschs ability to
offer complete systems and professional services complements and strengthens SCMs competitive
position and provides significant new opportunities for incremental revenue growth.
In Europe, over the next several quarters we believe our most significant revenue opportunity
comes from the new electronic health card program in Germany. Deployment of electronic health
insurance cards to Germanys 82 million citizens began in 2008 and the German government began
distribution of card reader terminals for the program in April 2009. Our government-certified
eHealth terminals are used in hospitals, pharmacies, physicians offices, nursing homes and
elsewhere to authenticate individual health card holders, allow them access to healthcare services
and manage medical records and insurance information. During the third quarter of 2009 however,
although SCM continued to be one of the most significant supplier of eHealth terminals purchased
for Germanys electronic healthcard rollout, sales were lower than expected due to slower than
anticipated adoption within the initial test region and a slowdown in the program following the
countrys recent national elections as a new coalition government reviews its priorities. While we
believe that the opportunity exists to sell higher volumes of terminals once the German eHealth
program is fully underway, the amount and timing of any increase in volume is uncertain due to the
current lack of support from the German government.
In other markets, the weak economic environment in Europe continues to constrict sales to both
established and new customers. In general, smart-card based security projects in all sectors are
experiencing delays or are limited in scale. At the same time, sales development activities we
initiated 12 to 18 months ago as part of our strategy to broaden our market and geographic
penetration are resulting in higher customer engagement than in past periods. During the third
quarter of 2009, we fulfilled a large order for smart card readers to support a national ID program
in Spain. Additionally, additional support for Hirschs market development activities has resulted
in increased sales of Hirsch products in Europe in the third quarter.
In Japan, the weak economic environment also continued to constrict sales. Outside Japan, we
have focused on adding new distribution partners in to penetrate new geographic markets in Asia and
have added sales resources and applied a more systematic and focused approach to sales in countries
such as China, India, Malaysia, the Philippines and Thailand.
In our business, we may experience significant variations in demand for our products quarter
to quarter. This is particularly true for our smart card reader products, a significant portion of
which are currently sold for smart card-based ID programs run by various U.S., European and Asian
governments. Sales of our smart card readers and chips for government programs are impacted by
testing and compliance schedules of government bodies as well as roll-out schedules for application
deployments, both of which contribute to variability in demand from quarter to quarter. Further,
this business is typically subject to seasonality based on governmental budget cycles, with lowest
sales in the first quarter and highest sales in the fourth quarter of each year. Additionally, we
are dependent on a small number of customers in our Security and Identity Solutions business
overall for a significant portion of our revenues.
Sales of our Digital Media and Connectivity products are less subject to variability based on
market or project demands than sales in our Security and Identity Solutions business; however, we
are dependent on a very small number of customers in this product segment, which can result in
fluctuations in sales levels from one period to another. The increasing popularity of on-line photo
finishing sites and the economic downturn has resulted in lower demand for retail photo kiosks,
which utilize our media readers.
Gross Profit Margin Trends
Our acquisition of Hirsch has resulted in an increase in our gross profit margin, as Hirschs
sales typically yield margins that are higher than sales of the SCM smart card reader products. We
expect that our gross profit margin will continue to benefit from this more favorable mix of
products going forward. Additionally, we have implemented ongoing cost reduction programs to
address pricing pressure in our business and these programs have generally resulted in ongoing
improvements to our product margins. We believe we should be able to offset ongoing pricing
pressure and material cost increases with continual improvements in our supply chain systems.
Operating Expense Trends
Our operating expenses in the third quarter of 2009 reflect the addition of expenses for the
Hirsch business, as well as approximately $0.8 million in transaction costs relating to our
proposed acquisition of Bluehill ID and $0.5 million in severance costs for our former chief
financial officer Stephan Rohaly, partially offset by a $1.2 million gain from the sale of our
office
25
building in India. Excluding the incremental expenses related to the Hirsch business and the
one-time expenses and credits described above, operating expenses decreased year over year and were
flat with the previous quarter.
During 2008, we increased research and development investment in order to develop card reader
terminals for the electronic health card program in Germany and new products for the contactless
market, and the majority of this work has now been completed. Similarly, Hirsch also increased its
engineering investment over the last several quarters to develop its next generation of
controllers, and we expect that research and development expenses in our business will decrease
from current levels once the development of these controllers is completed. As part of our growth
strategy, we have also made significant investments to build up sales resources and create business
development programs both in our traditional markets and also in the contactless market,
particularly in Asia and Latin America. We believe that currently we have sufficient resources in
place to address the market opportunities in our current business, including new opportunities with
Hirsch, and that sales and marketing expenses will remain relatively steady going forward. Over the
last 12 months, acquisition-related costs have been a significant factor in the increase in general
and administrative expenses. This may continue, as pursuing merger and merger and acquisition
opportunities is a component of our growth strategy. Going forward, we will continue to closely
manage our expenses, particularly general and administrative.
Results of Operations
The comparability of our operating results in the three and nine months ended September 30,
2009 with the three and nine months ended September 30, 2008 is primarily impacted by our
acquisition of Hirsch on April 30, 2009. For the first nine months of 2009, only five months of
operating results from the acquired Hirsch business are included.
Net Revenue. Summary information by business segment for the three and nine months ended
September 30, 2009 and 2008 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% change |
|
|
|
|
|
|
|
|
|
% change |
|
|
Three months ended |
|
period to |
|
Nine months ended |
|
period to |
|
|
September 30, |
|
period |
|
September 30, |
|
period |
|
|
2009 |
|
2008 |
|
|
|
|
|
2009 |
|
2008 |
|
|
|
|
Security and Identity Solutions |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
12,508 |
|
|
$ |
5,873 |
|
|
|
113 |
% |
|
$ |
26,479 |
|
|
$ |
15,758 |
|
|
|
68 |
% |
Gross profit |
|
|
6,069 |
|
|
|
2,748 |
|
|
|
|
|
|
|
12,999 |
|
|
|
7,172 |
|
|
|
|
|
Gross profit % |
|
|
49 |
% |
|
|
47 |
% |
|
|
|
|
|
|
49 |
% |
|
|
46 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Digital Media and Connectivity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
826 |
|
|
$ |
520 |
|
|
|
59 |
% |
|
$ |
2,971 |
|
|
$ |
3,619 |
|
|
|
(18 |
)% |
Gross profit |
|
|
325 |
|
|
|
162 |
|
|
|
|
|
|
|
1,080 |
|
|
|
1,244 |
|
|
|
|
|
Gross profit % |
|
|
39 |
% |
|
|
31 |
% |
|
|
|
|
|
|
36 |
% |
|
|
34 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
13,334 |
|
|
$ |
6,393 |
|
|
|
109 |
% |
|
$ |
29,450 |
|
|
$ |
19,377 |
|
|
|
52 |
% |
Gross profit |
|
|
6,394 |
|
|
|
2,910 |
|
|
|
|
|
|
|
14,079 |
|
|
|
8,416 |
|
|
|
|
|
Gross profit % |
|
|
48 |
% |
|
|
46 |
% |
|
|
|
|
|
|
48 |
% |
|
|
43 |
% |
|
|
|
|
Net revenue for the third quarter of 2009 was $13.3 million, up 109% from $6.4 million for the
same period of 2008. The increase in third quarter revenue year over year was primarily the result
of incremental revenues from the acquired Hirsch business. Excluding Hirsch, revenues were
relatively unchanged from the previous year. For the first nine months of 2009, net revenue was
$29.5 million, up 52% from revenue of $19.4 million for the first nine months of 2008. The increase
in revenue for the first nine months of 2009 compared with the prior year period resulted from
incremental revenues from our acquisition of
Hirsch in the second quarter of 2009, partially offset by lower sales of our smart card reader
products in the first nine months of 2009.
Following our acquisition of Hirsch, revenue in our Security and Identity Solutions business
principally consists of sales of smart card readers, related chip technology and access control
products that are primarily used in security programs where smart cards and/or personal
identification (PIN) codes are employed to authenticate the identity of people in order to
control access to computers or computer networks; borders; buildings and other facilities; and
services, such as health care. Additionally, this business includes sales of digital identity and
transaction platforms, as well as systems that integrate physical access control, secure data
storage and transmission, digital certificates, biometrics and digital video. Also included in this
business segment are
26
our CHIPDRIVE software and reader solutions, which provide electronic timecard and other
productivity applications for small and medium enterprises and are primarily sold in Europe. The
majority of revenue in our Security and Identity Solutions business segment is related to
government, financial or enterprise programs and is subject to variability based on the size and
timing of customer orders.
Revenues in our Security and Identity Solutions business were $12.5 million in the third
quarter of 2009, up 113% from $5.9 million in the third quarter of 2008. This increase was
primarily due to the inclusion of incremental revenues from the acquired Hirsch business. Sales of
SCM smart card reader products were also higher in Europe, offset by lower sales in the U.S. and
Asia. Hirsch sales in the third quarter were up year over year and included increases in both
product and services revenue. In addition to strong sales in the U.S. for government agency
deployments, focus on building channels and relationships in Europe and Asia resulted in new
revenue streams for Hirsch in these regions in the third quarter of 2009. The decrease in sales of
SCM smart card reader products in the U.S. and Asia was primarily the result of variability in the
timing of orders. Higher sales in Europe were the result of similar variability, and in particular
benefitted from a large order for an ID project in Spain. At the same time, European sales of our
CHIPDRIVE business productivity products aimed at small and medium enterprises continued to be
depressed as a result of the weak economic environment. Additionally, although SCM continued to be
one of the most significant supplier of eHealth terminals Germanys electronic healthcard rollout,
sales were lower than expected due to slower than anticipated adoption within the initial test
region and a slowdown in the program following the countrys recent national elections as a new
coalition government reviews its priorities.
For the first nine months of 2009, revenues in our Security and Identity Solutions business
were $26.5 million, up 68% from $15.8 million for the first nine months of 2008. The increase in
revenues in the first nine months of 2009 compared with the prior year was primarily due to the
inclusion of incremental revenues from the acquired Hirsch business beginning in the second quarter
of 2009. European sales of SCM smart card reader products were relatively unchanged in the first
nine months of 2009 compared with the prior year, while sales of SCM smart card reader products in
Asia were down approximately 13%.
Our Digital Media and Connectivity business consists of sales of digital media readers and
related ASIC technology used to provide an interface for flash memory cards, primarily embedded in
digital photography kiosks, where the readers are used to download and print digital photos. Two to
three customers, historically, have accounted for sales in this business segment. As a result,
revenue in our Digital Media Reader business can fluctuate significantly quarter to quarter due to
variability in the size and timing of customer orders.
Revenues in our Digital Media and Connectivity business were $0.8 million in the third quarter
of 2009, an increase of 59% from $0.5 million in the same period of 2008. For the first nine months
of 2009, sales in our Digital Media Reader business were $3.0 million, down 18% from sales of $3.6
million for the first nine months of 2008, primarily as a result of reduced consumer usage of photo
kiosks due to the economic downturn and competition with on-line photo finishing sites.
Gross Profit. Gross profit for the third quarter of 2009 was $6.4 million, or 48% of revenue,
compared with $2.9 million, or 46% of revenue in the third quarter of 2008. For the first nine
months of 2009, gross profit was $14.1 million, or 48% of revenue, compared with $8.4 million, or
43% of revenue for the first nine months of 2008. Gross profit in the three and nine months ended
September 30, 2009 was positively impacted by the inclusion of sales of higher-margin Hirsch
products in the 2009 periods.
Gross profit for our Security and Identity solutions was 49% of revenue for the third quarter
of 2009, compared with 47% for the third quarter of 2008. The increase in the third quarter of 2009
was primarily attributable to the inclusion of sales of higher-margin Hirsch products.
Gross profit for our Digital Media and Connectivity products was 39% for the third quarter of
2009, compared with 31% for the third quarter of 2008. The increase was primarily related to higher
margin business in the 2009 third quarter.
Overall gross profit for the first nine months of 2009 compared with the first nine months of
2008 was favorably impacted by the inclusion of sales of higher-margin Hirsch products and the
relative stability of gross profit in our Digital Media and Connectivity business.
We expect there will be some variation in our gross profit from period to period, as our gross
profit has been and will continue to be affected by a variety of factors, including, without
limitation, competition, the volume of sales in any given quarter, product configuration and mix,
the availability of new products, product enhancements, software and services, inventory
write-downs and the cost and availability of components.
27
Operating Expenses.
Research and Development.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% change |
|
|
|
|
|
|
|
|
|
% change |
|
|
Three months ended September 30 |
|
period to |
|
Nine months ended September 30 |
|
period to |
(In thousands) |
|
2009 |
|
2008 |
|
period |
|
2009 |
|
2008 |
|
period |
|
|
|
|
|
Expenses |
|
$ |
1,518 |
|
|
$ |
980 |
|
|
|
55 |
% |
|
$ |
3,776 |
|
|
$ |
3,058 |
|
|
|
23 |
% |
Percentage of total revenues |
|
|
11 |
% |
|
|
15 |
% |
|
|
|
|
|
|
13 |
% |
|
|
16 |
% |
|
|
|
|
Research and development expenses consist primarily of employee compensation and fees for the
development of hardware, software and firmware products. We focus the bulk of our research and
development activities on the development of products for new and emerging market opportunities.
Figures for the first nine months of 2009 include five months of expenses from our acquired Hirsch
business.
Research and development expenses in the third quarter of 2009 were $1.5 million, or 11% of
revenue, compared with $0.9 million, or 15% of revenue in the third quarter of 2008, an increase of
55%. For the first nine months of 2009, research and development expenses were $3.8 million, or 13%
of revenue, compared with $3.1 million, or 16% of revenue in the first nine months of 2008, an
increase of 23%. Higher research and development expenses in the three and nine months ended
September 30, 2009 compared with the same periods of 2008 were primarily due to the inclusion of
additional expenses related to the Hirsch business. We expect that research and development
expenses will generally decrease following the completion of development of Hirschs next
generation controllers.
Selling and Marketing.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% change |
|
|
|
|
|
|
|
|
|
% change |
|
|
Three months ended September 30 |
|
period to |
|
Nine months ended September 30 |
|
period to |
(In thousands) |
|
2009 |
|
2008 |
|
period |
|
2009 |
|
2008 |
|
period |
|
|
|
|
|
Expenses |
|
$ |
4,653 |
|
|
$ |
2,280 |
|
|
|
104 |
% |
|
$ |
10,635 |
|
|
$ |
7,010 |
|
|
|
52 |
% |
Percentage of total revenues |
|
|
35 |
% |
|
|
36 |
% |
|
|
|
|
|
|
36 |
% |
|
|
36 |
% |
|
|
|
|
Selling and marketing expenses consist primarily of employee compensation as well as tradeshow
participation, advertising and other marketing and selling costs. We focus a significant proportion
of our sales and marketing activities on new and emerging market opportunities. Figures for the
first nine months of 2009 include five months of expenses related to our acquired Hirsch business.
Selling and marketing expenses in the third quarter of 2009 were $4.7 million, or 35% of
revenue, compared with $2.3 million, or 36% of revenue in the third quarter of 2008, an increase of
104%. For the first nine months of 2009, sales and marketing expenses were $10.6 million, or 36% of
revenue, compared with $7.0 million, or 36% of revenue in the first nine months of 2008, an
increase of 52%. Higher sales and marketing expenses in the three and nine months ended September
30, 2009 compared with the same periods of 2008 were primarily due to the inclusion of additional
expenses related to the Hirsch business. Integration of our sales and marketing plans and
activities for SCM and Hirsch businesses is under way and the closure of our Fremont,
California office has been completed. Accordingly, we do not expect further increases in sales and
marketing expenses going forward as a result of the acquisition of Hirsch.
General and Administrative.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% change |
|
|
|
|
|
|
|
|
|
% change |
|
|
Three months ended September 30 |
|
period to |
|
Nine months ended September 30 |
|
period to |
(In thousands) |
|
2009 |
|
2008 |
|
period |
|
2009 |
|
2008 |
|
period |
|
|
|
|
|
Expenses |
|
$ |
2,978 |
|
|
$ |
1,697 |
|
|
|
75 |
% |
|
$ |
7,665 |
|
|
$ |
4,718 |
|
|
|
62 |
% |
Percentage of total revenues |
|
|
22 |
% |
|
|
27 |
% |
|
|
|
|
|
|
26 |
% |
|
|
24 |
% |
|
|
|
|
General and administrative expenses consist primarily of compensation expenses for employees
performing administrative functions, and professional fees arising from legal, auditing and other
consulting services. Figures for the first nine months of 2009 include five months of expenses
related to our acquired Hirsch business.
General and administrative expenses in the third quarter of 2008 were $3.0 million, or 22% of
revenue, compared with $1.7 million, or 27% of revenue in the third quarter of 2008, an increase of
75%. For the first nine months of 2009, general and administrative expenses were $7.7 million, or
26% of revenue, compared with $4.7 million, or 24% of revenue in the first nine months of 2008, an
increase of 62%. Higher general and administrative expenses in both the three and nine months ended
September 30, 2009 compared with the same periods of 2008 were primarily due to the inclusion of
additional expenses related to
28
the Hirsch business, as well as transaction related costs of $1.4 million in the first quarter,
$0.5 million in the second quarter and $0.8 million in the third quarter of 2009, and severance
costs of $0.5 million in the 2009 third quarter.
Gain on Sale of Assets. During the third quarter of 2009, we recorded $1.2 million gain on the
sale of our office building in India. During the first quarter of 2009, we recorded $0.2 million
gain on the sale of certain non-core patents that were unrelated to our current business.
Loss on Equity Investments. Net loss on equity investments of $0.2 million and $0.8 million
during the three and nine months ended September 30, 2009, respectively, relate to our share of the
net losses of our equity method investment in TranZfinity and amortization of the differences
between SCMs cost and underlying equity in net assets of TranZfinity, subsequent to the date of
investment.
Interest and Other Income (Expense), Net. This includes interest earned on invested cash,
interest accretion on the liability to related parties and foreign currency gains or losses.
In the third quarter of 2009, we recorded interest expense of $0.2 million, compared with
interest income of $0.2 million for the third quarter of 2008. In the first nine months of 2009,
interest expense was $0.3 million, compared with interest income of $0.6 million in the first nine
months of 2008. Following the acquisition of Hirsch, during the period from the April 30, 2009
acquisition of Hirsch to September 30, 2009, $0.3 million expense was recognized for the interest
accreted on the discounted liability amount to related parties (see Note 14).
Foreign currency gains were $0.1 million in the third quarter of 2009 compared with foreign
currency losses of $1.3 million in the third quarter of 2008. Foreign currency gains were $0.3
million in the first nine months of 2009 compared with foreign currency losses of $0.9 million for
the first nine months of 2008. Our foreign currency gains and losses primarily resulted from the
valuation of current assets and liabilities denominated in a currency other than the functional
currency of the respective entity in the local financial statements. Accordingly, these foreign
currency gains and losses were predominantly non-cash items. Foreign exchange losses in the 2008
periods were primarily the result of the weakening of the euro versus the U.S. dollar, as measured
at the end of each quarter.
Income Taxes. For the third quarter of 2009, we recorded a tax provision of $0.4 million,
which resulted primarily from the capital gains tax on the sale of our office building in India.
For the first nine months of 2009, we recorded a tax benefit of $1.3 million, which resulted
primarily from the accounting treatment following the acquisition of Hirsch, under which deferred
tax liabilities of $1.7 million were netted against SCMs existing deferred tax assets, and a $1.7
million release of SCMs valuation allowance was recorded. In accordance with ASC 805-10, the
release of the valuation allowance was recorded as a tax benefit in the financial statements for
the second quarter of 2009.
For the third quarter and first nine months of 2008, we recorded a provision for income taxes
of $0.1 million and $0.2 million, respectively, primarily for minimum taxation, which could not be
offset with operating loss carryforwards and tax expenses in a foreign subsidiary with no loss
carryforwards.
Discontinued Operations. On May 22, 2006, we completed the sale of substantially all the
assets and some of the liabilities associated with our DTV solutions business to Kudelski S.A. Net
revenue for the DTV solutions business was zero in each of the three and nine months ended
September 30, 2009 and 2008. Operating loss for the DTV solutions business in the three months
ended September 30, 2009 was $2,000. For the nine months ended September 30, 2009, operating gain
was $0.1 million. Operating gain for the DTV solutions business for the three and nine months ended
September 30, 2008 was $32,000 and $26,000, respectively.
During 2003, we completed two transactions to sell our retail Digital Media and Video
business. On July 25, 2003, we completed the sale of our digital video business to Pinnacle Systems
and on August 1, 2003, we completed the sale of our retail digital media reader business to Zio
Corporation. Net revenue for the retail Digital Media and Video business was zero in each of the
three and nine months ended September 30, 2009 and 2008. Operating loss for the retail Digital
Media and Video business was $0.1 million and $0.2 million, respectively, in the three and nine
months ended September 30, 2009, and operating loss for the retail Digital Media and Video business
was $0.1 and $0.2 million, respectively, in the three and nine months ended September 30, 2008.
During the three and nine months ended September 30, 2009, the total net gain on the disposal
of discontinued operations was $41,000 and $0.1 million, respectively. During the three and nine
months ended September 30, 2008, the total net gain on the disposal of discontinued operations was
$44,000 and $0.6 million, respectively.
29
Liquidity and Capital Resources
As of September 30, 2009, our working capital, which we have defined as current assets less
current liabilities, was $10.4 million, compared to $23.9 million as of December 31, 2008, a
decrease of approximately $13.5 million. The reduction in working capital primarily reflects a cash
payment for the Hirsch acquisition of $14.2 million, offset by an acquired cash balance from the
acquisition of $3.3 million. The further reduction in cash and cash equivalents primarily resulted
from operating activities. Current assets (excluding cash and cash equivalents) increased by $3.5
million and current liabilities increased by $2.6 million, also primarily as a result of including
the assets and liabilities acquired in the Hirsch transaction.
The following summarizes our cash flows for the nine months ended September 30, 2009 (in
thousands):
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
|
2009 |
|
Cash used in operating activities from continuing operations |
|
$ |
(4,725 |
) |
Cash used by operating activies from discontinued operations |
|
|
(128 |
) |
Cash used in investing activities |
|
|
(9,076 |
) |
Effect of exchange rate changes on cash and cash equivalents |
|
|
(459 |
) |
|
|
|
|
|
|
|
|
|
Decrease in cash and cash equivalents |
|
|
(14,388 |
) |
Cash and cash equivalents at beginning of period |
|
|
20,550 |
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
6,162 |
|
|
|
|
|
During the first nine months of 2009, cash used in operating activities was $4.9 million. The
net loss of $5.8, the non-cash impact from changes in deferred income taxes of $2.0 million and the
gain on disposal of property and equipment of $1.3 million was partly offset mainly by the non-cash
impact of the loss on equity investments of $0.8 million and cash provided from net changes in
operating assets and liabilities of approximately $2.9 million.
Significant commitments that will require the use of cash in future periods include
obligations under operating leases, inventory purchase commitments and other contractual
agreements. Gross committed lease obligations were approximately $4.9 million at September 30,
2009. Inventory and other purchase commitments due within one year were approximately $11.5
million, and additional purchase and contractual commitments due within two years were
approximately $1.0 million at September 30, 2009.
The
cash used in investing activities primarily reflects the cash payment for the Hirsch
acquisition of $14.2 million, offset by an acquired cash balance of $3.3 million from the
acquisition and the proceeds from sale of assets, net of $2.1 million primarily for the sale of our
office building in India.
Our liquidity plans are subject to a number of risks and uncertainties, including those
described in the section Risk Factors, some of which are outside our control. As with many
companies across various industries, our liquidity position and our operating performance were
negatively affected by the global economic downturn and by other financial and business factors,
many of which are beyond our control.
We currently expect that our current capital resources should be sufficient to meet our
operating and capital requirements at least through the end of 2009. We may, however, seek
additional debt or equity financing prior to that time. There can be no assurance that additional
capital will be available to us on favorable terms or at all. The sale of additional debt or equity
securities may cause dilution to existing stockholders.
Over the last year we also initiated various activities to preserve cash or generate
additional cash. For example in the fourth quarter of 2008 we began selling certain non-strategic
patents that are unrelated to our current business, which to date have generated $1.6 million in
cash. During the third quarter of 2009, we sold our office building in Chennai, India and recorded
a pre-tax gain of $1.2 million.
Critical Accounting Policies and Estimates
Managements Discussion and Analysis of Financial Condition and Results of Operations
discusses our consolidated financial statements, which have been prepared in accordance with U.S.
GAAP. The preparation of these financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the date of the
30
financial statements and the reported amounts of revenues and expenses during the reporting period.
On an on-going basis, management evaluates its estimates and judgments, including those related to
product returns, customer incentives, bad debts, inventories, asset impairment, deferred tax
assets, accrued warranty reserves, restructuring costs, contingencies and litigation. Management
bases its estimates and judgments on historical experience and on various other factors that are
believed to be reasonable under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different assumptions or
conditions.
Management believes the following critical accounting policies, among others, contain our more
significant judgments and estimates used in the preparation of our consolidated financial
statements.
|
|
|
We recognize product revenue upon shipment provided that risk and title have
transferred, a purchase order has been received, collection is determined to be reasonably
assured and no significant obligations remain. Maintenance revenue is deferred and
amortized over the period of the maintenance contract. Provisions for estimated warranty
repairs and returns and allowances are provided for at the time products are shipped. We
maintain allowances for doubtful accounts for estimated losses resulting from the inability
of our customers to make required payments. If the financial condition of our customers
were to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances might be required, which could have a material impact on our results
of operations. |
|
|
|
|
We typically plan our production and inventory levels based on internal forecasts of
customer demand, which are highly unpredictable and can fluctuate substantially. We
regularly review inventory quantities on hand and record an estimated provision for excess
inventory, technical obsolescence and inability to sell based primarily on our historical
sales and expectations for future use. Actual demand and market conditions may be different
from those projected by our management. This could have a material effect on our operating
results and financial position. If we were to make different judgments or utilize different
estimates, the amount and timing of our write-down of inventories could be materially
different. Once we have written down inventory below cost, we do not subsequently write it
up. |
|
|
|
|
Under ASC Topic 740-10, Income Taxes (ASC 740-10), we are required to make certain
judgments and estimates in determining income tax expense for financial statement purposes.
Significant changes to these estimates may result in an increase or decrease to our tax
provision in a subsequent period. The calculation of our tax liabilities requires dealing
with uncertainties in the application of complex tax regulations. ASC 740-10 prescribes a
recognition threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. It is
inherently difficult and subjective to estimate such amounts. We reevaluate such uncertain
tax positions on a quarterly basis based on factors such as, but not limited to, changes in
tax laws, issues settled under audit and changes in facts or circumstances. Such changes in
recognition or measurement might result in the recognition of a tax benefit or an
additional charge to the tax provision in the period. |
|
|
|
|
The carrying value of our net deferred tax assets reflects that we have been unable to
generate sufficient taxable income in certain tax jurisdictions. A valuation allowance is
provided for deferred tax assets if it is more likely than not these items will either
expire before we are able to realize their benefit, or that future deductibility is
uncertain. Management evaluates the realizability of the deferred tax assets quarterly. The
deferred tax assets are still available for us to use in the future to offset taxable
income, which would result in the recognition of a tax benefit and a reduction in our
effective tax rate. Actual operating results and the underlying amount and category of
income in future years could render our current assumptions, judgments and estimates of the
realizability of deferred tax assets inaccurate, which could have a material impact on our
financial position or results of operations. |
|
|
|
|
Resulting from the acquisition of Hirsch, we have recognized goodwill of $21.9 million.
Goodwill represents the excess of the purchase price over the fair value of the net
tangible and identifiable intangible assets acquired in a business combination. Goodwill is
not subject to amortization but is subject to annual assessment, at a minimum, for
impairment. We evaluate goodwill, at a minimum, on an annual basis and whenever events and
changes in circumstances indicate that the carrying amount of an asset may not be
recoverable. Impairment of goodwill is tested at the reporting unit level by comparing the
reporting units carrying value, including goodwill, to the fair value of the reporting
unit. The fair values of the reporting units are estimated using a combination of quoted
market prices, the income, or discounted cash flows, approach and the market approach,
which utilizes comparable companies data. If the carrying value of the reporting unit
exceeds the fair value, goodwill is considered impaired and a second step is performed to
measure the amount of the impairment loss, if any. |
31
|
|
|
We evaluate our long-lived assets and certain identifiable intangibles for
impairment whenever events or changes in circumstances indicate that the carrying amount of
such assets or intangibles may not be recoverable. Recoverability of assets to be held and
used is measured by a comparison of the carrying amount of an asset to future net
undiscounted cash flows expected to be generated by an asset. If such assets are considered
to be impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets. Intangible assets with
definite lives are being amortized using the straight-line method over the estimated useful
lives of the related assets. For intangible assets, where we have determined that these
have an indefinite useful life, no amortization is recognized until its useful life is
determined to be no longer indefinite. We evaluate indefinite useful life intangible assets
for impairment at a minimum on an annual basis and whenever events and changes in
circumstances indicate that the carrying amount of an asset may not be recoverable. |
|
|
|
|
We use the equity method of accounting for investments in unconsolidated entities where
the ability to exercise significant influence over such entities exists. Investments in
unconsolidated entities consist of capital contributions plus our share of accumulated
earnings of the entities, less capital withdrawals and distributions. Investments in excess
of the underlying net assets of equity method investees related to specifically
identifiable intangible assets, which are amortized over the useful life of the related
assets. Excess investment representing equity method goodwill is not amortized but is
generally evaluated for impairment on an annual basis. In case of adverse circumstances
arising which may impact the value of our investments, we also evaluate whether indications
for impairment exist on a case by case basis. Non-marketable equity investments are
inherently risky. Their success is dependent on product development, market acceptance,
operational efficiency, and other key business factors. Depending on future prospects,
these companies may not be able to raise additional funds when the funds are needed or they
may receive lower valuations, with less favorable terms than expected, and our investments
would likely become impaired. |
Recent Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 168, The FASB Accounting Standards Codification and the Hierarchy
of Generally Accepted Accounting Principlesa replacement of FASB Statement No. 162, (SFAS 168).
SFAS 168 replaces SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, and
establishes the FASB Accounting Standards Codification (the Codification) as the source of
authoritative accounting principles recognized by the FASB to be applied by nongovernmental
entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive
releases of the Securities and Exchange Commission (SEC) under authority of federal securities
laws are also sources of authoritative GAAP for SEC registrants. The FASB will no longer issue new
standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts;
instead the FASB will issue Accounting Standards Updates. Accounting Standards Updates will not be
authoritative in their own right as they will only serve to update the Codification. The issuance
of SFAS 168 and the Codification does not change GAAP. SFAS 168 became effective for us for the
period ending September 30, 2009. Management has determined that the adoption of SFAS 168 does not
have an impact on our financial statements.
On January 1, 2009, we adopted Topic ASC 805-10, Business Combinations (ASC 805-10). Under
ASC 805-10, an entity is required to recognize the assets acquired, liabilities assumed,
contractual contingencies, and contingent consideration at their fair value on the acquisition
date. It further requires that acquisition-related costs be recognized separately from the
acquisition and expensed as incurred, restructuring costs generally be expensed in periods
subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation
allowances and acquired income tax uncertainties after the measurement period be included in income
tax expense. In addition, acquired in-process research and development is capitalized as an
intangible asset and amortized over its estimated useful life. The adoption of ASC 805-10 changes
our accounting treatment for business combinations on a prospective basis.
On January 1, 2009, we adopted ASC Topic 810-10 Consolidation (ASC 810-10). ASC 810-10
changes the accounting and reporting for minority interests, which will be recharacterized as
non-controlling interests and classified as a component of equity. ASC 810-10 is effective for us
on a prospective basis for business combinations with an acquisition date beginning in the first
quarter of fiscal year 2009. As of September 30, 2009, we did not have any minority interests.
We adopted ASC Topic 820-10, Fair Value Measurements and Disclosures (ASC 820-10), as it
relates to nonfinancial assets and nonfinancial liabilities that are not recognized or disclosed at
fair value in the financial statements on at least an annual basis, on January 1, 2009 and we
adopted ASC 820-10, as it relates to all financial assets and financial liabilities and for all
non-financial assets and non-financial liabilities recognized or disclosed at fair value in the
financial statements on a recurring basis
32
(i.e., at least annually), on January 1, 2008. ASC 820-10 defines fair value, establishes a
framework for measuring fair value, and enhances fair value measurement disclosure. ASC 820-10 does
not change the accounting for those instruments that were, under previous GAAP, accounted for at
cost or contract value. The adoption of ASC 820-10 did not have a significant impact on our
consolidated financial statements.
ASC 820-10 establishes a fair value hierarchy that requires an entity to maximize the use of
observable objective inputs and minimize the use of unobservable inputs, which require additional
reliance on our judgment, when measuring fair value. A financial instruments categorization within
the fair value hierarchy is based upon the lowest level of input that is significant to the fair
value measurement. ASC 820-10 establishes three levels of inputs that may be used to measure fair
value:
|
|
|
Level 1 Quoted prices for identical instruments in active markets; |
|
|
|
|
Level 2 Quoted prices for similar instruments in active markets, quoted prices for
identical or similar instruments in markets that are not active and model-derived
valuations, in which all significant inputs are observable in active markets; and |
|
|
|
|
Level 3 Valuations derived from valuation techniques, in which one or more
significant inputs are unobservable. |
We use the following classifications to measure different financial instruments at fair value,
including an indication of the level in the fair value hierarchy in which each instrument is
generally classified:
Cash equivalents include highly liquid debt investments (money market fund deposits,
commercial paper and treasury bills) with maturities of three months or less at the date of
acquisition. These financial instruments are classified in Level 1 of the fair value hierarchy.
Short-term investments consist of corporate notes and United States government agency
instruments and are classified as available-for-sale. These financial instruments are classified in
Level 1 of the fair value hierarchy. As of September 30, 2009, we had no short-term investments.
Assets that are measured and recognized at fair value on a recurring basis classified under
the appropriate level of the fair value hierarchy as of September 30, 2009 and December 31, 2008
were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2009 |
|
December 31, 2008 |
|
|
Level 1 |
|
Level 2 |
|
Level 3 |
|
Total |
|
Level 1 |
|
Level 2 |
|
Level 3 |
|
Total |
Money market fund deposits |
|
$ |
1,927 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
1,927 |
|
|
$ |
9,426 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
9,426 |
|
Non-financial assets that are measured and recognized at fair value on a non-recurring
basis as of September 30, 2009 are as follows (in thousands); none existed as of December 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
|
Total |
|
Goodwill |
|
$ |
|
|
|
$ |
|
|
|
$ |
21,895 |
|
|
$ |
21,895 |
|
Acquired intangibles Hirsch Acquisition |
|
|
|
|
|
|
|
|
|
|
22,333 |
|
|
|
22,333 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total: |
|
$ |
|
|
|
$ |
|
|
|
$ |
44,228 |
|
|
$ |
44,228 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The valuation of the acquired intangible assets is classified as a Level 3 measurement,
because it was based on significant unobservable inputs and involved management judgment and
assumptions about market participants and pricing. In determining fair value of the acquired
intangible assets, we determined the appropriate unit of measure, the exit market and the highest
and best use for the assets, in accordance with ASC 820-10. The fair value of trade names and
existing technology acquired in the Hirsch acquisition was determined using relief from royalty
approach and the fair value of Hirschs customer relationships was determined excess earnings
approach. See Note 2 for further discussion of this acquisition. The discount rate used in the
valuation of the intangible assets was derived from a weighted average cost of capital analysis.
As of September 30, 2009 and December 31, 2008, there were no liabilities that are measured
and recognized at fair value on a recurring basis.
33
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no significant change in our exposure to market risk during the three months
ended September 30, 2009. For discussion of SCMs exposure to market risk, refer to Item 7A,
Quantitative and Qualitative Disclosures About Market Risk, contained in our Annual Report on Form
10-K for the year ended December 31, 2008.
Item 4. Controls and Procedures
|
(a) |
|
Evaluation of Disclosure Controls and Procedures |
As of September 30, 2009, SCM carried out an evaluation, as required in Rule 13a-15(b) under
the Exchange Act, under the supervision and with the participation of our management, including our
CEO and our then serving CFO, of the effectiveness of the design and operation of our disclosure
controls and procedures, as defined in Rule 13a-15(e) under the Exchange Act. Based on this
evaluation, our CEO and our then serving CFO concluded that, as of September 30, 2009, our
disclosure controls and procedures were effective to provide reasonable assurance that the
information required to be disclosed in our SEC reports that we file or furnish under the Exchange
Act (i) is recorded, processed, summarized and reported within the time periods specified in SEC
rules and forms, and (ii) is accumulated and communicated to our management, including our CEO and
CFO, as appropriate to allow timely decisions regarding required disclosure. In the course of this
evaluation, we sought to identify any significant deficiencies or material weaknesses in our
disclosure controls and procedures, to determine whether we had identified any acts of fraud
involving personnel who have a significant role in our disclosure controls and procedures, and to
confirm that any necessary corrective action, including process improvements, was taken. This
conclusion includes the fact that, on April 30, 2009, we acquired Hirsch. While the controls and
procedures for our Hirsch subsidiary have yet to be fully integrated, we have yet to find anything
that would change our conclusion as to the effectiveness of the Companys disclosure controls. The
overall goals of all of our evaluation activities are to monitor our disclosure controls and
procedures and to make modifications as necessary. We intend to maintain these disclosure controls
and procedures, modifying them as circumstances warrant.
Effective September 30, 2009, Stephan Rohaly resigned from his position as SCMs Vice
President Finance, Chief Financial Officer and Secretary. Martin Wimmer was appointed by SCMs
Board of Directors to serve as interim Chief Financial Officer, in addition to retaining his
current position of Vice President Finance, until SCMs Board of Directors names a new
Chief Financial Officer. Therefore, while Mr. Rohaly supervised and participated in the evaluation,
Mr. Wimmer is the current principal accounting officer that has certified as to Rule 13a-15(e).
|
(b) |
|
Changes in Internal Controls over Financial Reporting |
In connection with our continued monitoring and maintenance of our controls procedures as part
of the implementation of section 404 of the Sarbanes-Oxley Act of 2002, we continue to review,
revise and improve the effectiveness of our internal controls. We made no changes to our internal
control over financial reporting, as defined in Rules 13a-15(e) and 15(d)-15(e) under the
Securities Exchange Act of 1934, as amended, during the third quarter of 2009 that have materially
affected, or that are reasonably likely to materially affect, our internal control over financial
reporting.
|
(c) |
|
Inherent Limitations on Effectiveness of Controls |
A control system, no matter how well designed and operated, can only provide reasonable
assurances that the objectives of the control system are met. Because there are inherent
limitations in all control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within SCM have been or will be detected.
34
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we could become subject to claims arising in the ordinary course of
business or be named a defendant in lawsuits. While the outcome of such claims or other proceedings
cannot be predicted with certainty, our management expects that any such liabilities, to the extent
not provided for by insurance or otherwise, will not have a material adverse effect on our
financial condition, results of operations or cash flows.
Item 1A. Risk Factors
Our business and results of operations are subject to numerous risks, uncertainties and
other factors that you should be aware of, some of which are described below. The risks,
uncertainties and other factors described in the risk factors described below are not the only ones
facing our company. Additional risks, uncertainties and other factors not presently known to us or
that we currently deem immaterial may also impair our business operations. Any of the risks,
uncertainties and other factors could have a materially adverse effect on our business, financial
condition, results of operations, cash flows or product market share and could cause the trading
price of our common stock to decline substantially.
Risks of Market Dynamics
Disruption in the global financial markets may adversely impact the availability and cost of
credit.
We may seek or need to raise additional funds. Our ability to obtain financing for general
corporate and commercial purposes or acquisitions depends on our operating and financial
performance and is also subject to prevailing economic conditions and to financial, business and
other factors beyond our control. The global credit markets and the financial services industry
have been experiencing a period of unprecedented turmoil characterized by the bankruptcy, failure
or sale of various financial institutions. An unprecedented level of intervention from the United
States and other governments has been seen. As a result of such disruption, our ability to raise
capital may be severely restricted and the cost of raising capital through such markets or
privately may increase significantly at a time when we would like, or need, to do so. Either of
these events could have an impact on our flexibility to fund our business operations, make capital
expenditures, pursue additional expansion or acquisition opportunities, or make another
discretionary use of cash and could adversely impact our financial results. In any case, there can
be no assurance that such funds, if available at all, can be obtained on terms reasonable to us.
Continuing disruption in the global financial markets may adversely impact SCMs customers and
customer spending patterns and we could experience heightened credit risk to our accounts
receivable.
The current financial crisis may cause consumers, businesses and governments to defer
purchases in response to tighter credit, decreased cash availability and declining consumer
confidence. Accordingly, demand for our products could decrease and differ materially from our
current expectations. For example, as part of our focus on the commercial and industrial markets,
a portion of our business is subject to conditions in the commercial construction and renovation
sector. A decline in new commercial construction or a significant decline in renovation projects
due to the global economic recession could have a material adverse effect on the results of
operations of this business. Further, some of our customers may require substantial financing in
order to fund their operations and make purchases from us. The inability of these customers to
obtain sufficient credit to finance purchases of our products and meet their payment obligations to
us, or possible insolvencies of our customers, could result in decreased customer demand, an
impaired ability for us to collect on outstanding accounts receivable, significant delays in
accounts receivable payments, and significant write-offs of accounts receivable, each of which
could adversely impact our financial results.
Additionally, we are exposed to credit risk in our accounts receivable, and this risk is
heightened in times of economic weakness. We distribute our products both through third-party
resellers and directly to certain customers. A majority of our outstanding trade receivables are
not covered by collateral or credit insurance. We may not be able to monitor and limit our exposure
to credit risk on our trade and non-trade receivables, we may not be effective in limiting credit
risk and avoiding losses.
35
Disruption in the global financial markets may adversely impact our suppliers.
Our ability to meet customers demands depends, in part, on our ability to obtain timely and
adequate delivery of quality materials, parts and components or products from our suppliers.
Certain of our components are available only from a single source or limited sources. If certain
key suppliers were to become capacity constrained or insolvent as a result of the financial crisis,
it could result in a reduction or interruption in supplies or a significant increase in the price
of supplies, each of which would adversely impact our financial results. In addition, credit
constraints at key suppliers could result in accelerated payment of accounts payable by us,
impacting our cash flow.
Our markets are highly competitive.
The markets for our products are competitive and characterized by rapidly changing technology.
We believe that the principal competitive factors affecting the markets for our products include:
|
|
|
the extent to which products must support existing industry standards and provide
interoperability; |
|
|
|
|
the extent to which standards are widely adopted and product interoperability is
required within industry segments; |
|
|
|
|
the extent to which products are differentiated based on technical features, quality
and reliability, ease of use, strength of distribution channels and price; and |
|
|
|
|
the ability of suppliers to develop new products quickly to satisfy new market and
customer requirements. |
We currently experience competition from a number of companies in each of our target market
segments and we believe that competition in our markets is likely to intensify as a result of
anticipated increased demand for secure digital access products. We may not be successful in
competing against offerings from other companies and could lose business as a result.
We also experience indirect competition from certain of our customers who currently offer
alternative products or are expected to introduce competitive products in the future. For example,
we sell our products to many OEMs who incorporate our products into their offerings or who resell
our products in order to provide a more complete solution to their customers. If our OEM customers
develop their own products to replace ours, this would result in a loss of sales to those
customers, as well as increased competition for our products in the marketplace. In addition, these
OEM customers could cancel outstanding orders for our products, which could cause us to write down
inventory already designated for those customers. We may, in the future, face competition from
these and other parties that develop digital data security products based upon approaches similar
to or different from those employed by us. In addition, the market for digital information security
and access control products may ultimately be dominated by approaches other than the approach
marketed by us.
Many of our current and potential competitors have significantly greater financial, technical,
marketing, purchasing, distribution channel and other resources than we do. As a result, our
competitors may be able to respond more quickly to new or emerging technologies or standards and to
changes in customer requirements. Our competitors may also be able to devote greater resources to
the development, promotion and sale of products and may be able to deliver competitive products at
a lower end user price. Current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to increase the ability of their
products to address the needs of our prospective customers. Therefore, new competitors, or
alliances among competitors, may emerge and rapidly acquire significant market share. Increased
competition is likely to result in price reductions, reduced operating margins and loss of market
share.
Strategic Risks
Our future success will depend on our ability to keep pace with technological change and meet
the needs of our target markets and customers.
The markets for our products are characterized by rapidly changing technology and the need to
meet market requirements and to differentiate our products through technological enhancements, and
in some cases, price. Our customers needs change, new technologies are introduced into the market,
and industry standards are still evolving. As a result, product life cycles are often short and
difficult to predict, and frequently we must develop new products quickly in order to remain
competitive in light of new market requirements. Rapid changes in technology, or the adoption of
new industry standards, could render our existing products obsolete and unmarketable. Changes in
market requirements could render our existing solutions obsolete or could require us to expend more
on research and development efforts. For example, a significant portion of our revenues results
from the sale of
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access control panels that include certain design elements that are more than a decade old.
These controllers are typically used in a network architecture that may become outdated or
obsolete. If a product is deemed to be obsolete or unmarketable, then we might have to reduce
revenue expectations or write down inventories for that product. We may also lose market share.
Our future success will depend upon our ability to enhance our current products and to develop
and introduce new products with clearly differentiated benefits that address the increasingly
sophisticated needs of our customers and that keep pace with technological developments, new
competitive product offerings and emerging industry standards. We must be able to demonstrate that
our products have features or functions that are clearly differentiated from existing or
anticipated competitive offerings, or we may be unsuccessful in selling these products. Our failure
to develop, manufacture, launch and sell next-generation security products and architectures for
both physical and logical security could significantly affect our financial performance. In
addition, in cases where we are selected to supply products based on features or capabilities that
are still under development, we must be able to complete our product design and delivery process on
a timely basis, or risk losing current and any future revenue from those products. In developing
our products, we must collaborate closely with our customers, suppliers and other strategic
partners to ensure that critical development, marketing and distribution projects proceed in a
coordinated manner. Also, this collaboration is important because these relationships increase our
exposure to information necessary to anticipate trends and plan product development. If any of our
current relationships terminate or otherwise deteriorate, or if we are unable to enter into future
alliances that provide us with comparable insight into market trends, our product development and
marketing efforts may be adversely affected, and we could lose sales. We expect that our product
development efforts will continue to require substantial investments and we may not have sufficient
resources to make the necessary investments.
In some cases, we depend upon partners who provide one or more components of the overall
solution for a customer in conjunction with our products. If our partners do not adapt their
products and technologies to new market or distribution requirements, or if their products do not
work well, then we may not be able to sell our products into certain markets.
Because we operate in markets for which industry-wide standards have not yet been fully set,
it is possible that any standards eventually adopted could prove disadvantageous to or incompatible
with our business model and product lines. If any of the standards supported by us do not achieve
or sustain market acceptance, our business and operating results would be materially and adversely
affected.
Sales of our products depend on the development of emerging applications in our target markets
and on diversifying and expanding our customer base in new markets and geographic regions, and
with new products.
We sell our products primarily to address emerging applications that have not yet reached a
stage of mass adoption or deployment. For example, we sell our smart card readers for use in
various smart card-based security programs in Europe, such as electronic drivers licenses,
national IDs and e-passports, which are applications that are not yet widely implemented. We are
also focused on expanding sales of professional services, identity management and biometrics
products and solutions. The market for some of these solutions is at an early stage of development
compared to the market for traditional access control. Additionally, we have a strategy of
expanding sales of existing product lines into new geographic markets and diversifying and
expanding our customer base, and have recently added sales resources to target authentication
programs in the government and enterprise sectors in Asia, and have begun to target the photo kiosk
markets in Europe and Asia. Further, we have initiated business development activities aimed at
penetrating the worldwide financial services and enterprise markets with new contactless reader
products.
Because the markets for our products are still emerging, demand for our products is subject to
variability from period to period. There is no assurance that demand will become more predictable
as additional smart card programs demonstrate success. For example, across many of the markets we
target, our success is dependent upon the acceptance and adoption of security solutions such as
ours, and may be hindered by public perceptions regarding the intrusiveness of identity-related
solutions and the manner in which organizations use the information collected, or by legislation
related to privacy of information. If demand for products to enable smart card-based security
applications does not develop further and grow sufficiently, our revenue and gross profit margins
could decline or fail to grow. We cannot predict the future growth rate, if any, or size or
composition of the market for any of our products. Our target markets have not consistently grown
or developed as quickly as we have expected, and we have experienced delays in the development of
new products designed to take advantage of new market opportunities. Since new target markets are
still evolving, it is difficult to assess the competitive environment or the size of the market
that may develop. The demand and market acceptance for our products, as is common for new
technologies, is subject to high levels of uncertainty and risk and may be influenced by various
factors, including, but not limited to, the following:
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general economic conditions, for example the economic uncertainty caused by the
current global economic recession; |
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our ability to demonstrate to our potential customers and partners the value and
benefits of new products; |
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the ability of our competitors to develop and market competitive solutions for
emerging applications in our target markets and our ability to win business in advance of
and against such competition; |
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the adoption and/or continuation of industry or government regulations or policies
requiring the use of products such as our smart card readers or identity management
solutions; |
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the timing of large scale security programs involving smart cards and related
technology by governments, banks and enterprises; |
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the adoption of privacy legislation that requires a change to our products or causes
customers to discontinue the use of our products; |
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the ability of financial institutions, corporate enterprises, the U.S. government and
other governments to agree on industry specifications and to develop and deploy smart
card-based applications that will drive demand for smart card readers such as ours; and |
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the ability of high capacity flash memory cards to drive demand for digital media
readers, such as ours, that enable rapid transfer of large amounts of data, for example
digital photographs. |
We face risks associated with strategic transactions.
A component of our ongoing business strategy is to seek to buy businesses, products and
technologies that complement or augment our existing businesses, products and technologies. We have
in the past acquired or made, and from time to time in the future may acquire or make, investments
in companies, products and technologies that we believe are complementary to our existing
businesses, products and technologies.
For example, on October 1, 2008, we entered into a Stock Purchase Agreement with TranZfinity,
Inc., a privately held entity, pursuant to which we purchased 33.7% of the outstanding shares of
TranZfinity common stock for an aggregate purchase price of $2.5 million. The investment is
inherently high risk as the market for technologies or products manufactured by the entity in its
early stage at the time of the investment by us and such market may never be significant.
On April 30, 2009, SCM acquired Hirsch Electronics Corporation, a privately-held corporation
that designs, engineers, manufactures and markets software, hardware and services in the security
management system/physical access control market.
On September 21, 2009, we announced that we had signed a business combination agreement with
Bluehill ID AG. This business combination will require approval from our stockholders and it is
uncertain when the transaction will close, if at all.
Any acquisition could expose us to significant risks. To be successful, SCM will need to
combine and integrate the acquired business into our business. The combination of two companies is
a complex, costly and time-consuming process. As a result, the combined company must devote
significant management attention and resources to integrating the diverse business practices and
operations of the acquired company into SCM. The integration process may divert the attention of
our executive officers and management from day-to-day operations and disrupt our businesses and, if
implemented ineffectively, preclude realization of the full benefits expected from the transaction.
Failure to meet the challenges involved in successfully integrating another companys operations
with ours or otherwise to realize any of the anticipated benefits of an acquisition could cause an
interruption of, or a loss of momentum in, the activities of our combined company and could
adversely affect our results of operations. In addition, the integration of our two companies may
result in unanticipated problems, expenses, liabilities, competitive responses and loss of customer
relationships, and may cause our stock price to decline.
Acquisitions and strategic investments may also lead to substantial increases in non-current
assets, including goodwill. As a result of the Hirsch acquisition, SCM recorded goodwill in the
amount of $21.9 million. Write-downs of these assets due to unforeseen business developments may
materially and adversely impact our financial condition and results of operations.
Our business strategy also contemplates divesting portions of our business from time to time,
if and when we believe we would be able to realize greater value for our stockholders in so doing.
We have in the past sold, and may from time to time in the future sell, all or one or more portions
of our business. Any divestiture or disposition could expose us to significant risks, including,
without limitation, costly fees for legal and transaction-related services; diversion of management
resources; loss of
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key personnel; and reduction in revenue. Further, we may be required to retain or indemnify
the buyer against certain liabilities and obligations in connection with any such divestiture or
disposition and we may also become subject to third-party claims arising out of such divestiture or
disposition. In addition, we may not achieve the expected price in a divestiture transaction.
Failure to overcome these risks could have a material adverse effect on our financial condition and
results of operations.
We may not have uncovered all the risks associated with the acquisition of Hirsch and a
significant liability may be discovered.
There may be risks that we failed to discover in the course of performing our due diligence
investigations related to our acquisition of Hirsch, which could result in significant liabilities.
In connection with our acquisition of Hirsch, a subsidiary of SCM has assumed all of Hirschs
liabilities, both pre-existing and contingent, as a matter of law upon the exchange of all Hirsch
shares of common stock. The Merger Agreement between us and Hirsch did not provide for our
indemnification by the former Hirsch shareholders against any of Hirschs liabilities, should they
arise or become known after the closing of the acquisition. Furthermore, there is no escrow
account or indemnity agreement protecting us in the event of any breach of Hirschs representations
and warranties in the Merger Agreement. While we attempted to minimize risks by conducting due
diligence that we deemed appropriate under the circumstances, we may not have identified all
existing or potential risks. Any significant liability that may arise may harm our business,
financial condition, results of operations and prospects by requiring us to expend significant
funds to satisfy such liability.
The representations and warranties contained in the Merger Agreement between SCM and Hirsch were
made solely for purposes of the contract among SCM, Hirsch, and the merger subsidiaries, and
used as a tool for allocating risk among the parties, and therefore they may not accurately
characterize the actual state of facts or conditions of SCM or Hirsch.
The representations and warranties contained in the Merger Agreement between SCM and Hirsch
were made solely for purposes of the contract among SCM, Hirsch, and the merger subsidiaries, and
are used for the purpose of allocating risk among the parties, rather than establishing matters of
facts. Because the representations and warranties may not accurately characterize the actual state
of facts or conditions of SCM or Hirsch, no third party should rely upon the representations and
warranties in the Merger Agreement as statements of factual information.
Operational Risks
We have incurred and will incur significant expenses as a result of our acquisition of Hirsch,
which has reduced and will reduce the amount of capital available to fund our business.
We have incurred, and will continue to incur, significant expenses related to our acquisition
of Hirsch. These expenses include investment banking fees, legal fees, accounting fees, and
printing and other costs already incurred, a net cash outlay of approximately $11 million related
to payment for Hirsch shares, and integration and other costs. There may also be unanticipated
costs related to the acquisition on an ongoing basis. As a result, the capital available to fund
our activities has been and is expected to be further reduced. During 2009, if we are unsuccessful
in securing sufficient sales of terminals for the German eHealth program, or in generating
sufficient new revenues from the contactless market, then we would likely continue to require cash
to fund our operations. The remaining cash available to us might not be adequate in subsequent
years.
We have incurred operating losses and may not achieve profitability.
We have a history of losses with an accumulated deficit of $208.0 million as of September 30,
2009. In the future, we may not be able to achieve expected results, including any guidance or
outlook we may provide from time to time; we may continue to incur losses and we may be unable to
achieve or maintain profitability.
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Our quarterly and annual operating results will likely fluctuate.
Our quarterly and annual operating results have varied greatly in the past and will likely
vary greatly in the future depending upon a number of factors. Many of these factors are beyond our
control. We attempt to project our future expense levels based on our internal operating plans and
sales forecasts, and our operating costs are to a large extent fixed. As a result, we may not be
able to sufficiently reduce our costs in any given quarter to adequately compensate for an
unexpected near-term shortfall in revenues, and even a small shortfall could potentially adversely
affect financial results for a quarter. Our revenues, gross profit and operating results may
fluctuate significantly from quarter to quarter due to, among other things:
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business and economic conditions overall and in our markets; |
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the timing and amount of orders we receive from our customers that may be tied to
budgetary cycles, seasonal demand, product plans or program roll-out schedules; |
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cancellations or delays of customer product orders, contract amendments, or the loss of
a significant customer; |
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the terms of customer contracts that affect the timing of revenue recognition; |
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protests of federal, state or local government contract awards by competitors; |
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inaccurate forecasts or incomplete information from our channel partners; |
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potential effects of providing services as a prime contractor that may not carry gross
margins as high as those of our core solutions; |
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our ability to obtain an adequate supply of components on a timely basis; |
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poor quality in the supply of our components; |
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delays in the manufacture of our products; |
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the absence of significant backlog in our business; |
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our inventory levels; |
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our customer and distributor inventory levels and product returns; |
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competition; |
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new product announcements or introductions; |
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our ability to develop, introduce and market new products and product enhancements on a
timely basis, if at all; |
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our ability to successfully market and sell products into new geographic or market
segments; |
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the sales volume, product configuration and mix of products that we sell; |
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technological changes in the markets for our products; |
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the rate of adoption of industry-wide standards; |
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reductions in the average selling prices that we are able to charge due to competition
or other factors; |
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strategic acquisitions, sales and dispositions; |
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fluctuations in the value of foreign currencies against the U.S. dollar; |
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the timing and amount of marketing and research and development expenditures; |
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loss of key personnel; and |
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costs related to events such as dispositions, organizational restructuring, headcount
reductions, litigation or write-off of investments or goodwill. |
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Due to these and other factors, our revenues may not increase or even remain at their current
levels. Because a majority of our operating expenses are fixed, a small variation in our revenues
can cause significant variations in our operational results from quarter to quarter and our
operating results may vary significantly in future periods. Therefore, our historical results may
not be a reliable indicator of our future performance.
The pre-acquisition financial projections for both our business and Hirschs business that were
prepared in connection with our acquisition of Hirsch are only estimates of future results and
there is no assurance that actual results will not be different.
In connection with the acquisition of Hirsch, we and Hirsch each created financial projections
of our respective businesses. These financial projections are only estimates of possible future
operating results and not guarantees of future performance. The future operating results of each
company and of the combined company will be affected by numerous factors, including these Risk
Factors. The actual operating results will likely differ from these financial projections.
It is difficult to estimate operating results prior to the end of a quarter.
The two main components of revenues in any given quarter are sales of physical access control
solutions and smart card reader technology. In our physical access control business, sales tend to
be relatively linear (regularly spaced throughout the quarter), as they are tied to large projects
with more predictable timelines. Historically, many of our smart card reader customers have tended
to make a significant portion of their purchases towards the end of the quarter, in part because
they believe they are able to negotiate lower prices and more favorable terms. As a result, smart
card reader revenue in any quarter depends on contracts entered into or orders booked and shipped
in that quarter. This makes it difficult to predict revenues both in our smart card reader
business, and for the company overall. The timing of closing larger orders increases the risk of
quarter-to-quarter fluctuation in revenues. If orders forecasted for a specific group of customers
for a particular quarter are not realized or revenues are not otherwise recognized in that quarter,
our operating results for that quarter could be materially adversely affected. In addition, from
time to time, we may experience unexpected increases or decreases in demand for our products
resulting from fluctuations in our customers budgets, purchasing patterns or deployment schedules.
These occurrences are not always predictable and can have a significant impact on our results in
the period in which they occur.
If we do not accurately anticipate the correct mix of products that will be sold, we may be
required to record charges related to excess inventories.
Due to the unpredictable nature of the demand for our products, we are required to place
orders with our suppliers for components, finished products and services in advance of actual
customer commitments to purchase these products. Significant unanticipated fluctuations in demand
could result in costly excess production or inventories. In order to minimize the negative
financial impact of excess production, we may be required to significantly reduce the sales price
of the product to increase demand, which in turn could result in a reduction in the value of the
original inventory purchase. If we were to determine that we could not utilize or sell this
inventory, we may be required to write down its value, which we have done in the past. Writing down
inventory or reducing product prices could adversely impact our cost of revenues and financial
condition.
We may choose to take back unsold inventory from our customers.
If demand is less than anticipated, customers may ask that we accept returned products that
they do not believe they can sell. With the exception of our retail CHIPDRIVE products, we do not
have a policy relating to product returns. However, we may determine that it is in our best
interest to accept returns in order to maintain good relations with our customers. If we were to
accept product returns, we may be required to take additional inventory reserves to reflect the
decreased market value of slow-selling returned inventory, even if the products are in good working
order.
We are subject to a lengthy sales cycle and additional delays could result in significant
fluctuations in our quarterly operating results.
Our initial sales cycle for a new customer usually takes a minimum of six to nine months, and
even in the case of established customers, it may take up to a year for us to receive approval for
a given purchase from the customer. During this sales cycle, we may expend substantial financial
and managerial resources with no assurance that a sale will ultimately result. The length of a new
customers sales cycle depends on a number of factors, many of which we may not be able to control.
These factors include the customers product and technical requirements, the size and complexity of
the project, the customers budgeting process, the
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customers evaluation of our solutions and competitive factors, which in the case of
government projects may include a competitive bidding process. In addition, the delays inherent in
lengthy sales cycles raise additional risks that customers may cancel contracts or select solutions
from other vendors. Any delays in the sales cycle for new customers could delay or reduce our
receipt of new revenue and could cause us to expend more resources to obtain new customer wins. If
we are unsuccessful in managing sales cycles, our business could be adversely affected.
A significant portion of our sales typically comes from a small number of customers and the loss
of one or more of these customers or variability in the timing of orders could negatively impact
our operating results.
Our products are generally targeted at the government sector, commercial and industrial
markets, OEM customers in the consumer electronics, digital photo processing and computer
industries, as well as the financial sector and corporate enterprises. Sales to a relatively small
number of customers historically have accounted for a significant percentage of our revenues. Sales
to our top ten customers accounted for approximately 50% of our revenue in the third quarter of
2009 and 58% of revenue in fiscal 2008. We expect that sales of our products to a relatively small
number of customers will continue to account for a high percentage of our total sales for the
foreseeable future, particularly in our Digital Media and Connectivity business, where
approximately two-thirds of our business has typically been generated by two or three customers.
The loss of a customer or reduction of orders from a significant customer, including those due to
product performance issues, changes in customer buying patterns, or market, economic or competitive
conditions in our market segments, could significantly lower our revenues in any period and would
increase our dependence on a smaller group of our remaining customers. For example, in the first
quarter of 2009, sales of our digital media readers were significantly lower than in previous
quarters due to reduced orders from one major customer in this business. Variations in the timing
or patterns of customer orders could also increase our dependence on other customers in any
particular period. Dependence on a small number of customers and variations in order levels period
to period could result in decreased revenues, decreased margins, and/or inventory or receivables
write-offs and otherwise harm our business and operating results.
Our business could be adversely affected by significant changes in the contracting or fiscal
policies of governments and governmental entities.
We derive a substantial portion of our revenues from contracts with international, federal,
state and local governments and government agencies, and subcontracts under federal government
prime contracts. We believe that the success and growth of our business will continue to be
influenced by our successful procurement of government contracts either directly or through prime
contractors. Accordingly, changes in government contracting policies or government budgetary
constraints could directly affect its financial performance.
Among the factors that could adversely affect our government-related business are:
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changes in fiscal policies or decreases in available government funding or grants; |
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changes in government programs or applicable requirements; |
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the adoption of new laws or regulations or changes to existing laws or regulations; |
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changes in political or social attitudes with respect to security and defense issues; |
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potential delays or changes in the government appropriations process; and |
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delays in the payment of its invoices by government payment offices. |
These and other factors could cause governments and governmental agencies, or prime
contractors that purchase our products or services, to reduce their purchases under existing
contracts, to exercise their rights to terminate contracts at-will or to abstain from exercising
options to renew contracts, any of which could have an adverse effect on our business, financial
condition and results of operations. Many of our government customers are subject to stringent
budgetary constraints. The award of additional contracts from government agencies could be
adversely affected by existing or upcoming spending reduction efforts or budget cutbacks at these
agencies.
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A significant portion of our revenue is dependent upon sales to government programs, which
are impacted by uncertainty of timelines and budgetary allocations, delays in developing
technology standards, and changes in laws or regulations pertaining to security.
Large government programs are a primary target for our Security and Identity Solutions
business, as smart card technology is increasingly used to enable applications ranging from
authorizing building and network access for federal employees to paying taxes online, to citizen
identification, to receiving health care. Sales to U.S. government agencies and other entities
comprise a significant portion of our sales. Additionally, we have sold a significant proportion
of our smart card reader products to the U.S. government for PC and network access by military and
federal employees, and these sales have been an important component of our overall revenue.
Government-sponsored projects are typically characterized by the uncertainty of their
timelines and budget allocations and delays in developing technology standards to enable program
applications. Additionally, many government programs are subject to changes in laws or regulations,
such as those pertaining to authentication of government personnel, trade practices or health
insurance documentation. Changes in fiscal policies or decreases in available government funding or
grants could adversely affect our sales, as could changes in government programs or applicable
requirements. Additionally, discontinuance of, changes in, or lack of adoption of laws or
regulations pertaining to security could adversely affect our financial performance.
In recent periods, we have experienced a significant decrease in sales of our external smart
card readers to the U.S. government, primarily due to weaker demand in this market as a result of
ongoing project and budget delays and a movement by the U.S. government towards purchasing computer
equipment with embedded reader capabilities. We continue to believe that we remain a leading
supplier of smart card reader technology to the U.S. government market and that we are not losing
share to competitors. However, lower overall market demand and the replacement of external smart
card reader sales with sales of lower-priced interface chips for embedded readers have resulted in
reduced revenue from the U.S. government sector, which we believe is not likely to consistently
return to previous levels.
We anticipate that a significant portion of our future revenues will come from government
programs outside the U.S., such as national identity, e-government, e-health and others
applications. We currently supply smart card readers for various government programs in Europe and
Asia and are actively targeting additional programs in these areas as well as in Latin America. We
also have spent significant resources developing a range of e-health smart card terminals for the
German governments electronic health card program. However, the timing of government smart card
programs is not always certain and delays in program implementation are common. For example, while
the German government has stated that it plans to distribute new electronic health cards to its
citizens beginning in early 2009, and to put in place a corresponding network and card reader
infrastructure during 2009, there have already been delays in this program and the actual timing of
equipment and card deployments in the German e-health program remain uncertain. The continued delay
of government projects for any reason could negatively impact our sales.
We derive a substantial portion of our revenue through the sale of our solutions to U.S.
government entities, pursuant to government contracts which differ materially from standard
commercial contracts, involve competitive bidding and may be subject to cancellation or delay
without penalty, any of which may produce volatility in our revenues and earnings.
Government contracts frequently include provisions that are not standard in private commercial
transactions. For example, government contracts may include bonding requirements and provisions
permitting the purchasing agency to cancel or delay the contract without penalty in certain
circumstances. In addition, government contracts are frequently awarded only after formal
competitive bidding processes, which have been and may continue to be protracted, and typically
impose provisions that permit cancellation in the event that necessary funds are unavailable to the
public agency. In many cases, unsuccessful bidders for government agency contracts are provided the
opportunity to formally protest certain contract awards through various agency, administrative and
judicial channels. The protest process may substantially delay a successful bidders contract
performance, result in cancellation of the contract award entirely and distract management. We may
not be awarded contracts for which we bid, and substantial delays or cancellation of purchases may
even follow our successful bids as a result of such protests. Furthermore, local government agency
contracts may be contingent upon availability of matching funds from federal or state entities. Law
enforcement and other government agencies are subject to political, budgetary, purchasing and
delivery constraints which may cause our quarterly and annual revenues and operating results to
fluctuate in a manner that is difficult to predict.
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Our business could be adversely affected by negative audits by government agencies; we could be
required to reimburse the U.S. government for costs that we have expended on government
contracts; and our ability to compete successfully for future contracts could be materially
impaired.
Government agencies may audit our business as part of their routine audits and investigations
of government contracts. As part of an audit, these agencies may review our performance on
contracts, cost structures and compliance with applicable laws, regulations and standards. These
agencies may also review the adequacy of, and our compliance with, our own internal control systems
and policies, including our purchasing, property, estimating, compensation and management
information systems. If any of our costs are found to be improperly allocated to a specific
contract, the costs may not be reimbursed and any costs already reimbursed for such contract may
have to be refunded. An audit could materially affect our business competitive position and result
in a material adjustment to our financial results or statement of operations. If a government
agency audit uncovers improper or illegal activities, we may be subject to civil and criminal
penalties and administrative sanctions, including termination of contracts, forfeiture of profits,
suspension of payments, fines and suspension or debarment from doing business with the federal
government. In addition, our business could suffer serious harm to its reputation if allegations of
impropriety were made against it.
While our business has never had a negative audit by a governmental agency, we cannot assure
you that one will not occur. If we were suspended or barred from contracting with the federal
government generally, or if our reputation or relationships with government agencies were impaired,
or if the government otherwise ceased doing business with us or significantly decreased the amount
of business it does with us, our revenues and prospects would be materially harmed.
Some of our sales are made through distributors, and the loss of such distributors could result
in decreased revenue.
We currently use distributors, independent dealers/integrators to sell some of our products,
primarily into markets or customers where the distributor may have closer relationships or greater
access than we do. Some of these dealers also sell our competitors products, and if they favor our
competitors products for any reason, they may fail to market our products as effectively or to
devote resources necessary to provide effective sales, which would cause our sales to suffer.
Distribution arrangements are intended to benefit both us and the distributor, and may be long- or
short-term relationships, depending on market conditions, competition in the marketplace and other
factors. If we are unable to maintain effective distribution channels, there could be a reduction
in the amount of product we are able to sell, and our revenues could decrease.
Our business could suffer if our third-party manufacturers cannot meet production requirements.
Our products are manufactured in the United States and outside the United States by contract
manufacturers. Particularly, our reliance on foreign manufacturing poses a number of risks,
including, but not limited to:
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difficulties in staffing; |
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currency fluctuations; |
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potentially adverse tax consequences; |
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unexpected changes in regulatory requirements; |
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tariffs and other trade barriers; |
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export controls; |
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political and economic instability; |
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lack of control over the manufacturing process and ultimately over the quality of our
products; |
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late delivery of our products, whether because of limited access to our product
components, transportation delays and interruptions, difficulties in staffing, or
disruptions such as natural disasters; |
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capacity limitations of our manufacturers, particularly in the context of new large
contracts for our products, whether because our manufacturers lack the required capacity
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obsolescence of our hardware products at the end of the manufacturing cycle. |
The use of contract manufacturing requires us to exercise strong planning and management in
order to ensure that our products are manufactured on schedule, to correct specifications and to a
high standard of quality. If any of our contract manufacturers cannot meet our production
requirements, we may be required to rely on other contract manufacturing sources or
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identify and qualify new contract manufacturers. We may be unable to identify or qualify new
contract manufacturers in a timely manner or at all or with reasonable terms 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 supplies of our products from our current or
alternative manufacturers would materially and adversely affect our business and operating results.
In addition, if we are not successful at managing the contract manufacturing process, the quality
of our products could be jeopardized or inventories could be too low or too high, which could
result in damage to our reputation with our customers and in the marketplace, as well as possible
write-offs of excess inventory.
We have a limited number of suppliers of key components, and may experience difficulties in
obtaining components for which there is significant demand.
We rely upon a limited number of suppliers for some key components of our products. For
example, we currently utilize the foundry services of external suppliers to produce our ASICs for
smart cards readers, and we use chips and antenna components from third-party suppliers in our
contactless smart card readers. In our physical access control business, there are a few parts that
have reached end of life, for which there are limited sources, and the continued availability and
pricing of older components in the future is not guaranteed. Additionally, a significant portion of
our physical access control revenue is derived from the resale of cards and card readers from other
manufacturers, and we resell computers and servers; disruption of either of these supplies would
adversely affect us. Further, in our physical access control business, we outsource the stuffing of
printed circuit boards to local manufacturers. The bulk of that outsourcing is with a single
entity, and disruptions within that entity would adversely affect our business.
Our reliance on a limited number of suppliers may expose us to various risks including,
without limitation, an inadequate supply of components, price increases, late deliveries and poor
component quality. Disruption or termination of the supply of components or software used in our
products could delay shipments of our products. These delays could have a material adverse effect
on our business and operating results and could also damage relationships with current and
prospective customers. Additionally, any financial instability of, or consolidation among, our
suppliers could result in it having to find new sources for our products and components, which
could future impair or ability to deliver products to our customers and harm our operating results.
Security breaches in systems we sell or maintain could result in the disclosure of sensitive
government information or private personal information that could result in the loss of clients
and negative publicity.
Many of the systems we sell manage private personal information and protect information
involved in sensitive government functions. A security breach in one of these systems could cause
serious harm to our business as a result of negative publicity and could prevent us from having
further access to such systems or other similarly sensitive areas for other governmental clients.
As part of our technical support services, we agree, from time to time, to possess all or a
portion of the security system database of our customers. This service is subject to a number of
risks. For example, our systems may be vulnerable to physical or electronic break-ins and service
disruptions that could lead to interruptions, delays or loss of data. If any such compromise of our
security were to occur, it could be very expensive to correct, could damage our reputation and
could discourage potential customers from using our services. Although we have not experienced
attempted break-ins, we may experience such attempts in the future. Our systems may also be
affected by outages, delays and other difficulties. Our insurance coverage may be insufficient to
cover losses and liabilities that may result from such events.
Our products may have defects, which could damage our reputation, decrease market acceptance of
our products, cause us to lose customers and revenue and result in costly litigation or
liability.
Complex technical products and solutions such as ours may contain defects for many reasons,
including defective design or manufacture, defective material or software interoperability issues.
Often, these defects are not detected until after the products have been shipped. If any of our
products contain defects or perceived defects or have reliability, quality or compatibility
problems or perceived problems, our reputation might be damaged significantly, we could lose or
experience a delay in market acceptance of the affected product or products and we might be unable
to retain existing customers or attract new customers. In addition, these defects could interrupt
or delay sales or our ability to recognize revenue for products shipped. In the event of an actual
or perceived defect or other problem, we may need to invest significant capital, technical,
managerial and other resources to investigate and correct the potential defect or problem and
potentially divert these resources from other development efforts. If we are unable to provide a
solution to the potential defect or problem that is acceptable to our customers, we may be required
to
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incur substantial product recall, repair and replacement and even litigation costs. These
costs could have a material adverse effect on our business and operating results.
We provide warranties on certain product sales, which range from twelve to twenty-four months,
and allowances for estimated warranty costs are recorded during the period of sale. The
determination of such allowances requires us to make estimates of product return rates and expected
costs to repair or to replace the products under warranty. We currently establish warranty reserves
based on historical warranty costs for each product line combined with liability estimates based on
the prior twelve months sales activities. If actual return rates and/or repair and replacement
costs differ significantly from our estimates, adjustments to recognize additional cost of sales
may be required in future periods.
In addition, because our customers rely on our Secure Authentication products to prevent
unauthorized access to PCs, networks or facilities, a malfunction of or design defect in our
products (or even a perceived defect) could result in legal or warranty claims against us for
damages resulting from security breaches. If such claims are adversely decided against us, the
potential liability could be substantial and have a material adverse effect on our business and
operating results. Furthermore, the publicity associated with any such claim, whether or not
decided against us, could adversely affect our reputation. In addition, a well-publicized security
breach involving smart card-based or other security systems could adversely affect the markets
perception of products like ours in general, or our products in particular, regardless of whether
the breach is actual or attributable to our products. Any of the foregoing events could cause
demand for our products to decline, which would cause our business and operating results to suffer.
We have global operations, which require significant financial, managerial and administrative
resources.
Our business model includes the management of separate product lines that address disparate
market opportunities that are geographically dispersed. While there is some shared technology
across our products, each product line requires significant research and development effort to
address the evolving needs of our customers and markets. To support our development and sales
efforts, we maintain company offices and business operations in several locations around the world,
including Germany, Hong Kong, India, Italy, Japan and the United States. We also must manage
contract manufacturers in several different countries, including China and Singapore. Managing our
various development, sales, administrative and manufacturing operations places a significant burden
on our financial systems and has contributed to a level of operational spending that is
disproportionately high compared to our current revenue levels.
Operating in diverse geographic locations also imposes significant burdens on our managerial
resources. In particular, our management must:
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divert a significant amount of time and energy to manage employees and contractors
from diverse cultural backgrounds and who speak different languages; |
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travel between our different company offices; |
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maintain sufficient internal financial controls in multiple geographic locations that
may have different control environments; |
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manage different product lines for different markets; |
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manage our supply and distribution channels across different countries and business
practices; and |
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coordinate these efforts to produce an integrated business effort, focus and vision. |
Any failure to effectively manage our operations globally could have a material adverse effect
on our business and operating results.
We conduct a significant portion of our operations outside the United States. Economic,
political, regulatory and other risks associated with international sales and operations could
have an adverse effect on our results of operation.
In addition to our corporate headquarters being located in Germany, we conduct a substantial
portion of our business in Europe and Asia. Approximately 41% of our revenue for the nine months
ended September 30, 2009 and 57% of our revenue for the year ended December 31, 2008 was derived
from customers located outside the United States. Because a significant number of our principal
customers are located in other countries, we anticipate that international sales will continue to
account for a
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substantial portion of our revenues. As a result, a significant portion of our sales and
operations may continue to be subject to risks associated with foreign operations, any of which
could impact our sales and/or our operational performance. These risks include, but are not limited
to:
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changes in foreign currency exchange rates; |
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changes in a specific countrys or regions political or economic conditions and
stability, particularly in emerging markets; |
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unexpected changes in foreign laws and regulatory requirements; |
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export controls; |
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potentially adverse tax consequences; |
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longer accounts receivable collection cycles; |
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difficulty in managing widespread sales and manufacturing operations; and |
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less effective protection of intellectual property. |
Personnel Risks
Our key personnel and directors are critical to our business, and such key personnel may not
remain with us in the future.
We depend on the continued employment of our senior executive officers and other key
management and technical personnel. For example, some employees have cultivated relationships with
our customers, which makes us particularly dependent upon those employees continued employment with
us. We are also substantially dependent on the continued services of our existing engineering and
project management personnel because of the highly technical nature of our solutions. If any of our
key personnel were to leave and not be replaced with sufficiently qualified and experienced
personnel, our business could be adversely affected. In particular, our current strategy to
penetrate the market for contactless payment solutions is heavily dependent on the vision,
leadership and experience of our chief executive officer, Felix Marx.
We also believe that our future success will depend in large part on our ability to attract
and retain highly qualified technical and management personnel. However, competition for such
personnel is intense. We may not be able to retain our key technical and management employees or to
attract, assimilate or retain other highly qualified technical and management personnel in the
future.
Likewise, as a small, dual-traded company, we are challenged to identify, attract and retain
experienced professionals with diverse skills and backgrounds who are qualified and willing to
serve on our Board of Directors. The increased burden of regulatory compliance under the
Sarbanes-Oxley Act of 2002 creates additional liability and exposure for directors and financial
losses in our business and lack of growth in our stock price make it difficult for us to offer
attractive director compensation packages. If we are not able to attract and retain qualified board
members, our ability to practice a high level of corporate governance could be impaired.
Risks of Financial and Capital Markets
Our stock price has been and is likely to remain volatile.
Over the past few years, the NASDAQ Stock Market and the Prime Standard of the Frankfurt
Exchange have experienced significant price and volume fluctuations that have particularly affected
the market prices of the stocks of technology companies. Volatility in our stock price on either or
both exchanges may result from a number of factors, including, among others:
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low volumes of trading activity in our stock, particular in the U.S.; |
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variations in our or our competitors financial and/or operational results; |
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the fluctuation in market value of comparable companies in any of our markets; |
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expected, perceived or announced relationships or transactions with third parties; |
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comments and forecasts by securities analysts; |
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trading patterns of our stock on the NASDAQ Stock Market or Prime Standard of the
Frankfurt Stock Exchange; |
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the inclusion or removal of our stock from market indices, such as groups of
technology stocks or other indices; |
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loss of key personnel; |
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announcements of technological innovations or new products by us or our competitors; |
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announcements of dispositions, organizational restructuring, headcount reductions,
litigation or write-off of investments; |
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litigation developments; and |
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general market downturns. |
In the past, companies that have experienced volatility in the market price of their stock
have been the object of securities class action litigation. If we were the object of securities
class action litigation, it could result in substantial costs and a diversion of our managements
attention and resources.
SCM common stock has historically traded at a very low volume. The market price of SCM common
stock could decline as a result of the large number of shares that have been issued to the
former Hirsch shareholders and that will become eligible for sale in the future.
The new shares of SCM common stock issued as consideration in connection with the acquisition
of Hirsch will begin to become saleable on October 31, 2009 and the warrants to purchase shares of
SCM common stock will be exercisable for a two year period beginning on April 30, 2009.
Consequently, after such time, a substantial number of additional shares of SCM common stock will
be eligible for resale in the public market. Stockholders of SCM and former shareholders of Hirsch
may not wish to continue to invest in the operations of the combined company after Hirschs
acquisition by SCM, or for other reasons, may wish to dispose of some or all of their interests in
SCM. Sales of substantial numbers of shares of both the newly issued and the existing SCM common
stock in the public market following the closing of the acquisition could adversely affect the
market price of our stock.
You may experience dilution of your ownership interests due to the future issuance of additional
shares of our stock, and future sales of shares of our common stock could have an adverse effect
on our stock price.
In connection with the acquisition of Hirsch on April 30, 2009, after giving effect to the
acquisition, we issued approximately 9.4 million shares of SCM common stock, and warrants to
purchase approximately 4.7 million shares of SCM common stock, as consideration for the outstanding
shares of Hirsch common stock. In connection with our proposed business combination with Bluehill
ID, we plan to issue at least another 16,562,015 shares of SCM common stock as consideration for
the outstanding bearer shares in Bluehill ID. From time to time, we also may issue additional
previously authorized and unissued securities, resulting in the dilution of the ownership interests
of our current stockholders. We are currently authorized to issue up to 60,000,000 shares of common
stock. As of November 9, 2009, 25,134,985 shares of common stock were outstanding.
In 2007, our Board of Directors and our stockholders approved our 2007 stock option plan,
under which, as amended in October 2009, options to purchase 3.5 million shares of our common
stock may be granted. As of September 30, 2009, an aggregate of approximately 2.8 million shares of
common stock was reserved for future issuance under all our stock option plans, of which 2.3
million shares were subject to outstanding options. We may issue additional shares of our common
stock or other securities that are convertible into or exercisable for shares of common stock in
connection with the hiring of personnel, future acquisitions, future private placements, or future
public offerings of our securities for capital raising or for other business purposes. If we issue
additional securities, the aggregate percentage ownership of our existing stockholders will be
reduced. In addition, any new securities that we issue may have rights senior to those of our
common stock.
In addition, the potential issuance of additional shares of common stock or preferred stock,
or the perception that such issuances could occur, may create downward pressure on the trading
price of our common stock.
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The large percentage ownership of SCM common stock by Hirschs former shareholders gives those
shareholders significant influence over the outcome of corporate actions requiring stockholder
approval.
As a result of the acquisition, the former Hirsch shareholders beneficially own approximately
37% of SCMs common stock. Accordingly, the former Hirsch shareholders hold significant influence
over the outcome of any corporate transaction or other matter submitted to the SCM stockholders for
approval, including the election of directors, any merger, consolidation or sale of all or
substantially all of SCMs assets or any other significant corporate transaction, such that such
former shareholders of Hirsch could delay or prevent a change of control of SCM, even if such a
change of control would benefit our other stockholders. The interests of the former Hirsch
shareholders may differ from the interests of other stockholders.
Two of our directors directly or indirectly hold significant amounts of our common stock, and
both of them could have significant influence over the outcome of corporate actions requiring
board and stockholder approval, respectively.
As of November 9, 2009, Lincoln Vale held approximately 6.1% of the outstanding shares of our
common stock. As of October 1, 2009, Lincoln Vale also beneficially owned approximately 9.8% of
the outstanding bearer shares in Bluehill ID. Upon the closing of the offer it is anticipated that
Lincoln Vale will beneficially own approximately 7.8% of the outstanding shares of SCM common
stock. Dr. Hans Liebler, one of our directors, is a partner of Lincoln Vale and may also be deemed
to beneficially own, either directly or indirectly through limited partnerships, the shares
invested by Lincoln Vale in SCM. In addition, as of November 9, 2009, Lawrence Midland, a director
and an executive vice president of SCM, held approximately 5% of our common stock. Mr. Midlands
shares are held in a family trust and in custodianship for his children, and he may be deemed to
beneficially own the SCM shares. Accordingly, Dr. Liebler, Lincoln Vale and Lawrence Midland could
each have significant influence over the outcome of corporate actions requiring board and
stockholder approval, respectively, including the election of directors, any merger, consolidation
or sale of all or substantially all of our assets or any other significant corporate transaction.
In addition, Dr. Liebler, Lincoln Vale and Lawrence Midland could each delay or prevent a change of
control of SCM, even if such a change of control would benefit our other stockholders.
The sale of equity securities may cause the aggregate percentage ownership of our existing
stockholders to be reduced.
We may obtain additional capital through the sale of equity securities to increase our
flexibility to pursue additional expansion or acquisition opportunities, make capital expenditures,
fund our business operations or make another discretionary use of cash. If we are able to obtain
additional capital through the sale of equity securities, the aggregate percentage ownership of our
existing stockholders may be reduced. In addition, any new securities that we issue may have
rights senior to those of our common stock.
Our listing on both the NASDAQ Stock Market and the Prime Standard of the Frankfurt Stock
Exchange exposes our stock price to additional risks of fluctuation.
Our common stock is listed both on the NASDAQ Stock Market and the Prime Standard of the
Frankfurt Stock Exchange and we typically experience the majority of our trading on the Prime
Standard. Because of this, factors that would not otherwise affect a stock traded solely on the
NASDAQ Stock Market may cause our stock price to fluctuate. For example, European investors may
react differently and more positively or negatively than investors in the United States to events
such as acquisitions, dispositions, one-time charges and higher or lower than expected revenue or
earnings announcements. A significant positive or negative reaction by investors in Europe to such
events could cause our stock price to increase or decrease significantly. The European economy and
market conditions in general, or downturns on the Prime Standard specifically, regardless of the
NASDAQ Stock Market conditions, also could negatively impact our stock price.
Provisions in our agreements, charter documents, Delaware law and our rights plan may delay or
prevent the acquisition of SCM by another company, which could decrease the value of your
shares.
Our certificate of incorporation and bylaws and Delaware law contain provisions that could
make it more difficult for a third party to acquire us or enter into a material transaction with us
without the consent of our Board of Directors. These provisions include a classified Board of
Directors and limitations on actions by our stockholders by written consent. Delaware law imposes
some restrictions on mergers and other business combinations between us and any holder of 15% or
more of our outstanding common stock. In addition, our Board of Directors has the right to issue
preferred stock without stockholder approval, which could be used to dilute the stock ownership of
a potential hostile acquirer.
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We have adopted a stockholder rights plan. The triggering and exercise of the rights would
cause substantial dilution to a person or group that attempts to acquire us on terms or in a manner
not approved by our Board of Directors, except pursuant to an offer conditioned upon redemption of
the rights. While the rights are not intended to prevent a takeover of our company, they may have
the effect of rendering more difficult or discouraging an acquisition of us that was deemed to be
undesirable by our Board of Directors.
These provisions will apply even if the offer were to be considered adequate by some of our
stockholders. Because these provisions may be deemed to discourage a change of control, they may
delay or prevent the acquisition of our company, which could decrease the value of our common stock
Legal and Regulatory Risks
Our business could be adversely affected by changes in laws or regulations pertaining to
security.
The U.S. federal government, contractors to the federal government and certain industries in
the public sector currently fall, or may in the future fall, under particular regulations
pertaining to security. Some of the laws, regulations, certifications or requirements that may
stimulate new security systems sales include the following:
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Homeland Security Presidential Directive (HSPD) 12 and Federal Information Processing
Standards (FIPS) 201 produced by National Institute of Standards and Technology (NIST); |
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Federal Information Security Management Act (FISMA); |
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Transportation Security Administrations (TSA) Transportation Worker Identification Credential (TWIC) program; |
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Sarbanes-Oxley Act of 2002 (also known as the Public Company Accounting Reform and Investor Protection Act); |
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Health Insurance Portability and Accountability Act (HIPAA); |
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Gramm-Leach Bliley Act of 1999 (GLBA, a.k.a., the Financial Modernization Act); |
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Customs-Trade Partnership Against Terrorism (C-TPAT); |
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Free and Secure Trade Program (FAST); |
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Chemical Facility Anti Terrorism Standards (CFATS); and |
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various codes of the Code of Federal Regulations (CFR). |
Discontinuance of, changes in, or lack of adoption of laws or regulations pertaining to
security could adversely affect our performance.
We are subject to extensive government regulation, and any failure to comply with applicable
regulations could subject us to penalties that may restrict our ability to conduct our business.
Our business is affected by and must comply with various government regulations that impact
its operating costs, profit margins and its internal organization and operations. Furthermore, our
business may be audited to assure compliance with these requirements. Any failure to comply with
applicable regulations, rules and approvals could result in the imposition of penalties, the loss
of government contracts or the cancellation of our General Services Administration contract, any of
which could adversely affect our business, financial condition and results of operations. Among the
most significant regulations affecting our business are the following:
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the Federal Acquisition Regulations, or the FAR, and agency regulations supplemental to
the FAR, which comprehensively regulate the formation and administration of, and
performance under government contracts; |
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the Truth in Negotiations Act, which requires certification and disclosure of all cost
and pricing data in connection with contract negotiations; |
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the Cost Accounting Standards, which impose accounting requirements that govern our
right to reimbursement under cost-based government contracts; |
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the Foreign Corrupt Practices Act; and |
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laws, regulations and executive orders restricting the use and dissemination of
information classified for national security purposes and the exportation of certain
products and technical data. |
These regulations affect how our customers can do business with us, and, in some instances,
the regulations impose added costs on our business. Any changes in applicable laws and regulations
could restrict our ability to conduct its business. Any failure to comply with applicable laws and
regulations could result in contract termination, price or fee reductions or suspension or
debarment from contracting with the federal government generally.
If we are unable to continue to obtain U.S. government authorization regarding the export of our
products, or if current or future export laws limit or otherwise restrict our business, we could
be prohibited from shipping our products to certain countries, which could cause our business,
financial condition and results of operations to suffer.
In our business, we must comply with U.S. laws regulating the export of our products. In some
cases, explicit authorization from the U.S. government is needed to export our products. The export
regimes and the governing policies applicable to our business are subject to changes. We cannot be
certain that such export authorizations will be available to us or for our products in the future.
In some cases, we rely upon the compliance activities of our prime contractors, and we cannot be
certain they have taken or will take all measures necessary to comply with applicable export laws.
If we or our prime contractor partners cannot obtain required government approvals under applicable
regulations, we may not be able to sell our products in certain international jurisdictions.
We face risks from litigation.
From time to time, we may be subject to litigation, which could include, among other things,
claims regarding infringement of the intellectual property rights of third parties, product
defects, employment-related claims, and claims related to acquisitions, dispositions or
restructurings. Any such claims or litigation may be time-consuming and costly, divert management
resources, cause product shipment delays, require us to redesign our products, require us to accept
returns of products and to write off inventory, or have other adverse effects on our business. Any
of the foregoing could have a material adverse effect on our results of operations and could
require us to pay significant monetary damages.
For example, in connection with our acquisition of Hirsch, a complaint was filed against the
Company, Felix Marx and Hirsch, alleging multiple causes of action in connection with our
acquisition of Hirsch and a pre-existing settlement agreement. This case was ultimately settled;
however, other potential lawsuits could arise in connection with our acquisition activities that
may be concluded in a manner adverse to us that could have a material adverse effect on our
business, financial condition and results of operations.
We expect the likelihood of intellectual property infringement and misappropriation claims may
increase as the number of products and competitors in our markets grows and as we increasingly
incorporate third-party technology into our products. As a result of infringement claims, we could
be required to license intellectual property from a third-party or redesign our products. Licenses
may not be offered when we need them or on acceptable terms. If we do obtain licenses from third
parties, we may be required to pay license fees or royalty payments or we may be required to
license some of our intellectual property to others in return for such licenses. If we are unable
to obtain a license that is necessary for us or our third-party manufacturers to manufacture our
allegedly infringing products, we could be required to suspend the manufacture of products or stop
our suppliers from using processes that may infringe the rights of third parties. We may also be
unsuccessful in redesigning our products. Our suppliers and customers may be subject to
infringement claims based on intellectual property included in our products. We have historically
agreed to indemnify our suppliers and customers for patent infringement claims relating to our
products. The scope of this indemnity varies, but may, in some instances, include indemnification
for damages and expenses, including attorneys fees. We may periodically engage in litigation as a
result of these indemnification obligations. Our insurance policies exclude coverage for
third-party claims for patent infringement.
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We may be exposed to risks of intellectual property infringement by third parties.
Our success depends significantly upon our proprietary technology. We currently rely on a
combination of patent, copyright and trademark laws, trade secrets, confidentiality agreements and
contractual provisions to protect our proprietary rights, which afford only limited protection. We
may not be successful in protecting our proprietary technology through patents, it is possible that
no new patents will be issued, that our proprietary products or technologies are not patentable or
that any issued patent will fail to provide us with any competitive advantages.
There has been a great deal of litigation in the technology industry regarding intellectual
property rights, and from time to time we may be required to use litigation to protect our
proprietary technology. This may result in our incurring substantial costs and we may not be
successful in any such litigation.
Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to
copy aspects of our products or to use our proprietary information and software without
authorization. In addition, the laws of some foreign countries do not protect proprietary and
intellectual property rights to the same extent as do the laws of the United States. Because many
of our products are sold and a significant portion of our business is conducted outside the United
States, our exposure to intellectual property risks may be higher. Our means of protecting our
proprietary and intellectual property rights may not be adequate. There is a risk that our
competitors will independently develop similar technology or duplicate our products or design
around patents or other intellectual property rights. If we are unsuccessful in protecting our
intellectual property or our products or technologies are duplicated by others, our business could
be harmed.
Changes in tax laws or the interpretation thereof, adverse tax audits and other tax matters may
adversely affect our future results.
A number of factors may impact our tax position, including:
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the jurisdictions in which profits are determined to be earned and taxed; |
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the resolution of issues arising from tax audits with various tax authorities; |
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changes in the valuation of our deferred tax assets and liabilities; |
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adjustments to estimated taxes upon finalization of various tax returns; |
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increases in expenses not deductible for tax purposes; and |
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the repatriation of non-U.S. earnings for which we have not previously provided for
U.S. taxes. |
Any of these factors could make it more difficult for us to project or achieve expected tax
results. An increase or decrease in our tax liabilities due to these or other factors could
adversely affect our financial results in future periods.
Changes to financial accounting standards may affect our results of operations and cause us to
change our business practices.
We prepare our financial statements to conform with U.S. GAAP. These accounting principles are
subject to interpretation by the Financial Standards Accounting Board, the American Institute of
Certified Public Accountants, the Securities and Exchange Commission and various other bodies
formed to interpret and create appropriate accounting rules and policies. A change in those rules
or policies could have a significant effect on our reported results and may affect our reporting of
transactions completed before a change is announced. Any changes in accounting rules or policies in
the future may result in significant accounting charges.
We face costs and risks associated with maintaining effective internal controls over financial
reporting, and if we fail to achieve and maintain adequate internal controls over financial
reporting, our business, results of operations and financial condition, and investors
confidence in us could be materially affected.
Under Sections 302 and 404 of the Sarbanes-Oxley Act of 2002, our management is required to
make certain assessments and certifications regarding our disclosure controls and internal controls
over financial reporting. We have dedicated, and expect to continue to dedicate, significant
management, financial and other resources in connection with our compliance with Section 404 of the
Sarbanes-Oxley Act. The process of maintaining and evaluating the effectiveness of these controls
is expensive, time-
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consuming and requires significant attention from our management and staff. During the course
of our evaluation, we may identify areas requiring improvement and may be required to design
enhanced processes and controls to address issues identified through this review. This could result
in significant delays and costs to us and require us to divert substantial resources, including
management time from other activities. We have found a material weakness in our internal controls
in the past and we cannot be certain in the future that we will be able to report that our controls
are without material weakness or to complete our evaluation of those controls in a timely fashion.
If we fail to maintain an effective system of disclosure controls or internal control over
financial reporting, we may not be able to rely on the integrity of our financial results, which
could result in inaccurate or late reporting of our financial results and investigation by
regulatory authorities. If we fail to achieve and maintain adequate internal controls the financial
position of our business could be harmed; current and potential future shareholders could lose
confidence in us and/or our reported financial results, which may cause a negative effect on the
trading price of our common stock; and we could be exposed to litigation or regulatory proceedings,
which may be costly or divert management attention.
In addition, all internal control systems, no matter how well designed and operated, can only
provide reasonable assurance that the objectives of the control system are met. Because there are
inherent limitations in all control systems, no evaluation of control can provide absolute
assurance, that all control issues and instances of fraud, if any, within the Company have been or
will be detected. Projections of any evaluation of controls effectiveness to future periods are
subject to risks. Over time, controls may become inadequate because of changes in conditions or
deterioration in the degree of compliance with policies or procedures. Any failure of our internal
control systems to be effective could adversely affect our business.
Risks Relating to the Proposed Business Combination with Bluehill ID
We may not realize all of the anticipated benefits of the business combination.
To be successful after the business combination, SCM and Bluehill ID will need to integrate
their current businesses, operations and structure. The combination of two independent companies is
a complex, costly and time-consuming process. As a result, the combined companies will be required
to devote significant management attention and resources to integrating the diverse business
practices and operations of SCM and Bluehill ID. The integration process may divert the attention
of our executive officers and management from day-to-day operations and disrupt the business of
either or both of the companies and, if implemented ineffectively, preclude realization of the
expected benefits of the business combination. Failure to meet the challenges involved in
successfully integrating the operations of SCM and Bluehill ID or otherwise to realize any of the
anticipated benefits of the business combination could cause an interruption of, or a loss of
momentum in, the activities of the combined company and could adversely affect its results of
operations. In addition, the overall integration of the two companies may result in unanticipated
problems, expenses, liabilities, competitive responses and loss of customer relationships, and may
cause SCMs stock price to decline. The difficulties of combining the operations of the companies
include, among others:
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maintaining employee morale and retaining key employees; |
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preserving important strategic and customer relationships; |
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the diversion of managements attention from ongoing business concerns; |
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coordinating geographically separate organizations; |
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unanticipated issues in integrating information, communications and other systems; |
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coordinating marketing functions; |
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consolidating corporate and administrative infrastructures and eliminating duplicative
operations; and |
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integrating the cultures of SCM and Bluehill ID. |
In addition, even if the businesses and operations of SCM and Bluehill ID are integrated
successfully, the combined company may not fully realize the expected benefits of the business
combination, including sales or growth opportunities that were anticipated, within the anticipated
time frame, or at all. Further, because the businesses of SCM and Bluehill ID differ, the results
of operations of the combined company and the market price of SCM common stock after the business
combination may be affected by factors different from those existing prior to the business
combination and may suffer as a result of the business
53
combination. Cross product sales, increased geographical sales coverage and other synergies
may not occur or develop to the extent envisioned for the future. As a result, we cannot assure you
that the integration of the businesses and operations of SCM with Bluehill ID will result in the
realization of the full benefits anticipated from the business combination.
Provisions of the business combination agreement between SCM and Bluehill ID may deter
alternative business combinations.
Restrictions in the business combination agreement prohibit, in certain contexts, SCM and
Bluehill ID from soliciting any acquisition proposal or offer for a combination with any other
party, including a proposal that could be advantageous to the stockholders of SCM when compared to
the terms and conditions of the proposed transaction with Bluehill ID. In addition, if the business
combination agreement is terminated under certain specified circumstances relating to effecting a
business combination with a different party, depending upon the circumstances, we may be required
to pay Bluehill ID a lump sum termination fee of $1.5 million or $2.0 million. These provisions may
deter third parties from proposing or pursuing alternative business combinations that could result
in greater value to SCM stockholders than the business combination.
The amount of consideration in SCMs offer to Bluehill ID shareholders is fixed and not subject
to adjustment based on the market price of SCM common stock.
Holders of bearer shares in Bluehill ID who tender their shares pursuant to the offer will
receive 0.52 shares of SCM common stock for each bearer share in Bluehill ID tendered. The business
combination agreement does not include an adjustment mechanism based on increases or decreases in
the market price of SCM common stock for the determination of the amount of consideration that will
be paid.
The value of SCM common stock issued in the transaction will depend on its market price at the
time of the closing of the offer, as the exchange ratio for the bearer shares in Bluehill ID at
the closing of the offer is fixed.
Pursuant to the business combination agreement between SCM and Bluehill ID, the share exchange
ratio of 0.52 shares of SCM common stock that Bluehill ID shareholders will receive for each bearer
share in Bluehill ID tendered is unaffected by the share price of SCM common stock, as reflected on
the NASDAQ Stock Market or the Frankfurt Stock Exchange. Increases in the value of SCM common stock
or decreases in the value of Bluehill ID stock will result in a higher price being paid by SCM for
bearer shares in Bluehill ID and more value received by Bluehill ID shareholders in the business
combination. Pursuant to the business combination agreement, SCM will not have the right to
terminate or renegotiate the business combination agreement as a result of any increase in the
price per share or value of the SCM common stock.
The market price of SCM common stock could decline as a result of the large number of shares
that will become eligible for sale after the business combination.
If the transaction is consummated, the new shares of SCM common stock issued will become
saleable immediately following the closing of SCMs offer to Bluehill ID shareholders.
Consequently, a substantial number of additional shares of SCM common stock will be eligible for
resale in the public market. Current stockholders of SCM and former shareholders of Bluehill ID may
not wish to continue to invest in the operations of the combined companies after the business
combination, or for other reasons, may wish to dispose of some or all of their interests in SCM
after the business combination. Sales of substantial numbers of shares of both the newly issued and
the existing SCM common stock in the public market following the business combination could
adversely affect the market price of such shares.
The issuance of shares of SCM common stock to Bluehill ID shareholders in connection with the
offer will substantially reduce the percentage ownership of current SCM stockholders.
If the offer is completed and assuming that all currently outstanding bearer shares in
Bluehill ID are tendered during the course of the offer, SCM and Bluehill ID expect that SCM will
issue approximately 16,562,015 shares of SCM common stock as consideration for the outstanding
bearer shares in Bluehill ID. This does not include shares of SCM common stock that may be issued
or be issuable due to the conversion of options or rights to acquire or receive bearer shares in
Bluehill ID in connection with the transactions contemplated by the business combination agreement.
SCM stockholders will continue to own their existing shares of SCM common stock, which will not be
affected by the business combination, except that the issuance of the shares of SCM common stock
described above will cause a significant reduction in the relative percentage interests of current
SCM stockholders in earnings and voting, as well as liquidation, book and market value.
54
Bluehill ID is a significant stockholder of SCM, and its priorities as a stockholder of SCM may
be different from SCMs other stockholders. Additionally, Bluehill IDs current shareholders
will own a large percentage of the SCM common stock after the business combination, and will
have significant influence over the outcome of corporate actions requiring stockholder
approval; such stockholders priorities for SCMs business may be different from SCMs current
stockholders.
As of November 9, 2009, Bluehill ID beneficially owned and had the right to vote 1,201,004
shares of SCM common stock, and Ayman Ashour, Bluehill IDs CEO and President of its board of
directors, beneficially owned and had the right to vote an additional 104,000 shares; Bluehill ID
and Mr. Ashour, collectively, beneficially own approximately 5.2% of the outstanding shares of SCM
common stock. Accordingly, as a party to the business combination, Bluehill ID not only has a
significant interest in the outcome of the SCM special meeting of its stockholders to consider the
proposal to approve the offer to Bluehill ID shareholders and, specifically, the issuance of the
shares of SCM common stock in connection with the offer, it can also influence the outcome of the
proposals being considered at the SCM special meeting. The board of directors of Bluehill ID,
including Messrs. Ashour and Wenzel and Dr. Boersch, will have the power to determine how the
shares of SCM common stock owned by Bluehill ID will be voted at the SCM special meeting of its
stockholders. Bluehill ID may have objectives and interests that are different than those of SCMs
other stockholders.
If all of the bearer shares in Bluehill ID currently outstanding are tendered in the offer,
post-offer the current stockholders of SCM will hold approximately 60% of the outstanding shares of
SCM common stock and the current shareholders of Bluehill ID will hold approximately 40% of the
outstanding shares of SCM common stock. Accordingly, such former Bluehill ID shareholders may be
able to significantly influence the outcome of any corporate transaction or other matter submitted
to the SCM stockholders for approval, including the election of directors, any merger,
consolidation or sale of all or substantially all of SCMs assets or any other significant
corporate transaction, such that such former shareholders of Bluehill ID could delay or prevent a
change of control of SCM, even if such a change of control would benefit SCMs other stockholders.
The interests of such former Bluehill ID shareholders may differ from the interests of other
stockholders.
In addition, immediately after the closing of the offer to Bluehill ID shareholders, it is
anticipated that Bluehill IDs largest shareholder, Mountain Partners AG, together with its
affiliates and certain related parties, including BH Capital Management AG, Daniel S. Wenzel and
Dr. Cornelius Boersch, will directly or indirectly beneficially own approximately 25.2% of the
outstanding shares of SCM common stock; and Ayman S. Ashour will directly or indirectly
beneficially own, including through BH Capital Management AG, approximately 10.8% of the
outstanding shares of SCM common stock. Mr. Wenzel and Dr. Boersch, who currently serve as
directors of Bluehill ID and Mountain Partners AG, and Mr. Ashour are expected to be appointed to
SCMs board of directors following the closing of the offer. Accordingly, Mr. Ashour, Mountain
Partners AG, Mr. Wenzel and Dr. Cornelius Boersch will have significant influence over the outcome
of corporate actions requiring board and stockholder approval.
SCMs interests in Bluehill ID may be further diluted.
Bluehill ID is a party to the call option agreement with BH Capital Management AG, a company
controlled and owned by Ayman S. Ashour and Mountain Partners AG, which is an affiliate of Daniel
S. Wenzel and Dr. Cornelius Boersch, dated September 8, 2009, which grants BH Capital Management AG
an option to purchase up to 3,914,790 bearer shares in Bluehill ID. In addition, former
shareholders of subsidiaries of Bluehill ID, including Yoonison BV, ACiG AG, TagStar Systems GmbH
and Multicard AG Multicard GmbH, as well as a seller of assets acquired by Multicard AG, are
parties to the earn out agreements, pursuant to which bearer shares in Bluehill ID will be issued
to these beneficiaries upon the achievement of specific performance targets. The actual number of
bearer shares in Bluehill ID that are issuable under the earn out agreements will be based on the
average trading price of a bearer share in Bluehill ID in the month prior to issuance. Based on an
average price per share of a bearer shares in Bluehill ID during the month of September 2009 of
0.77818, up to an aggregate of 1,161,685 bearer shares in Bluehill ID could be issuable under the
earn out agreements. Bluehill ID has also authorized and implemented the Bluehill ID option plans.
Bluehill ID has a conditional share capital under which up to 4,000,000 bearer shares in Bluehill
ID may be issued in connection with the Bluehill ID option plans. Pursuant to the business
combination agreement, Bluehill ID will use all commercially reasonable efforts, adopt resolutions
and enter into agreements, as may be required, with SCM and third parties such that, after the
closing of the offer, the call option agreement, the earn out agreements and the Bluehill ID option
plans shall cease to represent a right to acquire or receive shares in Bluehill ID and shall
instead represent a right to acquire or receive shares of SCM common stock. If, however, respective
counter-parties do not enter into such agreements, these counter-parties remain entitled to acquire
or receive bearer shares in Bluehill ID, which could lead to a dilution of SCM with regard to our
interests in Bluehill ID.
55
If less than 90% of Bluehill IDs current shareholders tender their shares in the Offer, SCM
will not be able to effect a squeeze out merger under Swiss law and Bluehill ID will continue
to have minority shareholders.
If 90% or more of Bluehill IDs shareholders tender their shares in the offer, under Swiss
law, SCM would be able to effect a squeeze-out merger of Bluehill ID, pursuant to which Bluehill
ID would be merged with and into a wholly-owned subsidiary of SCM to be newly formed, resulting in
the dissolution of Bluehill ID. If SCM does not acquire at least 90% of Bluehill ID, there is a
risk that the squeeze-out merger would not be approved by the required 90% of votes of Bluehill ID,
and therefore a squeeze-out merger would not be possible. As a result, Bluehill ID would remain a
separate legal entity and Bluehill IDs remaining minority shareholders will continue to have
certain rights as provided by Swiss corporate law or under Bluehill IDs articles of incorporation
which will restrict SCMs corporate flexibility and result in additional costs to SCM. Such
minority rights include the right to participate at shareholder meetings, the right to information,
the right to initiate a special audit, the right to call a meeting of shareholders, the right to
profit and liquidation proceeds, and pre-emptive subscription rights.
If the conditions to the offer are not met or waived, the business combination will not occur.
Even if the offer and the issuance of the shares of SCM common stock to be issued in the offer
are approved by the stockholders of SCM, specified conditions must be satisfied or waived to
complete the offer. We cannot assure you that all of the conditions will be satisfied. If the
conditions are not satisfied or waived, the business combination will not occur or will be delayed,
which would result in the loss of some or all of the expected benefits of the business combination.
Certain conditions of the offer may be waived by SCM without re-soliciting SCM stockholder
approval.
The offer is subject to the satisfaction of certain conditions set forth in the business
combination agreement. SCM may entirely or partially waive certain of these conditions at its sole
discretion until the end of the working day prior to the expiry of the offer. In the event of a
waiver of any condition, SCM will not be required to resolicit our stockholders, and may complete
the transaction without seeking further stockholder approval.
The date on which the offer will close is uncertain.
The date on which the offer will close depends on the satisfaction of the conditions set forth
in the business combination agreement, or the waiver of certain of those conditions by SCM or
Bluehill ID. While we expect to complete the business combination at the beginning of 2010, the
completion date of the transaction might be later than expected because of unforeseen events.
If NASDAQ determines that the business combination will result in a change of control of SCM, we
will be required to submit an initial listing application and meet all initial NASDAQ Stock
Market inclusion criteria.
In connection with the proposed business combination, NASDAQ will review the terms and
anticipated effect of the business combination to determine if a change of control will be deemed
to occur under its rules. If NASDAQ determines that the business combination will result in a
change of control of SCM, we will be required to submit an initial listing application and meet all
initial NASDAQ inclusion criteria as set forth in the Marketplace Rules of NASDAQ, and pay all
applicable fees, before consummation of the transaction. If we are required to submit an initial
listing application, NASDAQs review of such application may take several weeks, which could cause
a delay in the consummation of the offer. There is also a risk that SCM will not meet NASDAQs
listing requirements and that NASDAQ may not approve the initial listing application without
substantial revision or delay, or at all.
If the business combination is not consummated, we may not be successful in our strategy to grow
revenue and increase our operational scale.
One of the components of our growth strategy is to increase our revenues and operational scale
through merger and acquisition activity. If the proposed business combination with Bluehill ID is
not consummated, then we may not be able to increase our revenues or operational scale as rapidly
as we have planned, or at all. If we are unable to increase our revenues or are not able to
increase our operational scale, we may not be able to fully leverage our global infrastructure, or
to pursue our other growth strategies effectively. We may elect to pursue mergers or acquisitions
with other companies, and there is no guarantee that these efforts will be successful.
Additionally, if the transaction is not consummated, then the financial and other resources that we
have expended on the transaction may not be recoverable.
56
We have incurred and will incur significant expenses as a result of the business combination
with Bluehill ID, which will reduce the amount of capital available to fund the combined
company.
We have incurred, and will continue to incur, significant expenses related to the business
combination. These expenses include investment banking fees, legal fees, accounting fees, and
printing and other costs. There may also be unanticipated costs related to the business
combination. As a result, we will have less capital available to fund our activities after the
business combination.
After the business combination, we will continue to incur significant costs as a result of
operating as a public company, and our management may be required to devote substantial time to
compliance initiatives.
As a U.S. public company, SCM currently incurs significant legal, accounting and other
expenses. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the
Securities and Exchange Commission and the NASDAQ Stock Market, have imposed various requirements
on public companies, including requiring establishment and maintenance of effective disclosure and
financial controls and changes in corporate governance practices. Our management and other
personnel devote a substantial amount of time and financial resources to these compliance
initiatives.
After the business combination, Bluehill ID, as a subsidiary of SCM, will be subject to the
Sarbanes-Oxley Act, and SCM will continue to be subject to all of the same obligations. Bringing
Bluehill ID into compliance will require significant expenditures and place additional demands on
SCMs management and may divert our managements time and attention away from the day-to-day
operations of the business. These obligations may also require us to hire additional personnel
after the business combination. Bluehill ID is currently evaluating its internal controls systems
in order to enable SCM to report on, and SCMs independent registered public accounting firm after
the business combination to attest to, internal controls, as required by Section 404 of the
Sarbanes-Oxley Act. SCM and Bluehill ID cannot be certain as to the timing of completion of the
evaluation, testing and remediation actions or the impact of the same on the operations of SCM
after the business combination. If, after the business combination, we fail to staff our accounting
and finance function adequately, or maintain internal controls adequate to meet the demands that
are placed upon us as a U.S. public company, including the requirements of the Sarbanes-Oxley Act,
we may be unable to report our financial results accurately or in a timely manner and our business
and stock price may suffer. The costs of being a public company, as well as diversion of
managements time and attention, may have a material adverse effect on our future business,
financial condition and results of operations.
Qualified management, marketing, and sales personnel are difficult to locate, hire and train,
and if we cannot attract and retain qualified personnel after the business combination, it will
harm the ability of our business to grow.
SCM and Bluehill ID have each grown their businesses through the services of many people. The
success of the combined company depends, in part, on the continued service of key managerial,
marketing and sales personnel. Competition for qualified management, technical, sales and marketing
employees is intense. In addition, the personnel policies and practices of SCM and Bluehill ID may
be less compatible than anticipated and, after the business combination, some employees might leave
the combined companies and go to work for competitors. We cannot assure you that we will be able to
attract, retain and integrate employees to develop and continue our business and strategies after
the business combination.
Completion of the business combination will require a significant amount of attention from our
management and this diversion of management attention away from ongoing operations could
adversely affect ongoing operations and business relationships.
Because completing the business combination requires a substantial amount of attention, this
will divert a significant amount of our managements attention away from the day-to-day operations
of our business. As a result, our business relationships and ongoing operations may suffer during
this period.
We may not have uncovered all the risks associated with the acquisition of Bluehill ID and a
significant liability may be discovered after the closing of the offer.
There may be risks that we failed to discover in the course of performing our due diligence
investigations related to the acquisition of Bluehill ID, which could result in significant
liabilities arising after the consummation of the transaction. The business combination agreement
does not provide for SCMs indemnification by the former Bluehill ID shareholders against any of
Bluehill IDs liabilities, should they arise or become known after the closing of the offer.
Furthermore, there is no escrow account or indemnity agreement protecting us in the event of any
breach of Bluehill IDs representations and warranties in the
57
business combination agreement. Any significant liability that may arise may harm our
business, financial condition, results of operations and prospects by requiring us to expend
significant funds to satisfy such liability.
The financial projections for both our business and Bluehill IDs business that were prepared in
connection with the proposed business combination are only estimates of future results and there
is no assurance that actual results will not be different.
In connection with our proposed business combination with Bluehill ID, we and Bluehill ID each
created financial projections of our respective businesses. These financial projections are only
estimates of possible future operating results and not guarantees of future performance. The future
operating results of each company and of the combined company will be affected by numerous factors,
including these Risk Factors. The actual operating results will likely differ from these
financial projections.
Bluehill IDs corporate records may be incomplete.
Certain Bluehill ID Group Companies were not able to provide SCM with complete corporate
records as part of the due diligence process in order to document the history of their share
ownership, and certain share transfers may be non-compliant with form requirements applicable to
such share transfer. Besides uncertainties as to the ownership in any such Bluehill ID Group
Company, this could result in difficulties with performing corporate functions, future challenges
to shareholders resolutions passed or potential litigation involving the Bluehill ID Group Company
concerned. Any of the foregoing may have a material adverse effect on our business, financial
condition or its results of operations.
Provisions of the business combination agreement regarding the payment of a termination fee to
Bluehill ID could negatively affect our business operations if the business combination
agreement is terminated.
In the event the transaction is terminated by SCM in circumstances that obligate us to pay the
lump sum termination fee of either $1.5 million or $2.0 million depending on the reason for the
termination, the results of our business operations may be adversely impacted.
Our customers may seek to change the existing business relationship with us in reaction to the
announcement or completion of the business combination.
In response to the announcement or completion of the business combination, existing or
prospective customers may delay or defer their procurement or other decisions, or they may seek to
change their existing business relationship. Any delay or deferral in product purchase or other
decisions by customers could have a material adverse effect on our business, regardless of whether
the transaction is ultimately completed.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
In June 2009, the Company issued warrants to purchase 39,692 shares of SCM common stock,
exercisable for two years beginning on April 30, 2012, at an exercise price of $3.00 per share.
The warrants were issued and the underlying shares will be issued on the basis of an exemption from
registration under Section 4(2) of the Securities Act of 1933, as amended. The warrants were
issued in connection with the service of certain individuals as former directors of Hirsch in 2008,
other than Lawrence Midland, pursuant to the Merger Agreement between SCM and Hirsch.
Item 3. Defaults upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
58
Item 5. Other Information.
Effective September 30, 2009, Stephan Rohaly resigned from his position as SCMs Vice
President Finance, Chief Financial Officer and Secretary. Martin Wimmer was appointed by SCMs
Board of Directors to serve as interim Chief Financial Officer, in addition to retaining his
current position of Vice President Finance, until SCMs Board of Directors names a new
Chief Financial Officer.
As of November 9, 2009, Lincoln Vale beneficially owned and had the right to vote
approximately 6.1% of the outstanding shares of SCM common stock, and approximately 9.8% of the
outstanding bearer shares in Bluehill ID. Upon the closing of the offer to Bluehill ID
shareholders, it is anticipated that Lincoln Vale will beneficially own approximately 7.8% of the
outstanding shares of SCM common stock. Dr. Hans Liebler, one of our directors, is a partner of
Lincoln Vale and may be deemed to beneficially own, either directly or indirectly through limited
partnerships, the shares beneficially owned by Lincoln Vale.
As of November 9, 2009, Bluehill ID beneficially owned and had the right to vote 1,201,004
shares of SCM common stock and Ayman Ashour, Bluehill IDs CEO and President of its board of
directors, beneficially owned 104,000 shares, and Bluehill ID and Mr. Ashour, collectively,
beneficially owned approximately 5.2% of the currently outstanding shares of SCM common stock.
Upon the closing of the offer to Bluehill ID shareholders, it is anticipated that Mr. Ashour will
be appointed to serve as executive chairman of SCMs board of directors.
Item 6. Exhibits.
Exhibits are listed on the Index to Exhibits at the end of this Quarterly Report. The exhibits
required by Item 601 of Regulation S-K, listed on such Index in response to this Item, are
incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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Registrant
SCM MICROSYSTEMS, INC.
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November 16, 2009 |
/s/ Felix Marx
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Felix Marx |
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Chief Executive Officer |
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November 16, 2009 |
/s/ Martin Wimmer
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Martin Wimmer |
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Vice President and Interim Chief Financial Officer |
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59
EXHIBIT INDEX
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Exhibit |
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Number |
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DESCRIPTION OF DOCUMENT |
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3.1(1)
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Fourth Amended and Restated Certificate of Incorporation, as amended. |
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3.2(3)
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Amended and Restated Bylaws of Registrant. |
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3.3(4)
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Certificate of Designation of Rights, Preferences and Privileges of
Series A Participating Preferred Stock of SCM Microsystems, Inc. |
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4.1(2)
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Form of Registrants Common Stock Certificate. |
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4.2(4)
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Preferred Stock Rights Agreement, dated as of November 8, 2002,
between SCM Microsystems, Inc. and American Stock Transfer and Trust
Company. |
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4.3(5)
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First Amendment to Rights Agreement, dated as of December 10, 2008,
between SCM Microsystems, Inc. and American Stock Transfer and Trust
Company. |
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4.4(5)
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Form of Warrant Certificate. |
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10.35(6)*
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Employment Agreement of Lawrence W. Midland, dated December 10, 2008. |
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10.36(6)
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Stockholder Agreement, dated December 10, 2008. |
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10.37(6)
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Settlement Agreement, dated April 8, 2009. |
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10.38(7)
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Amended and Restated 1994 Settlement Agreement, dated April 8, 2009. |
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10.39(7)
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Limited Guarantee, dated April 8, 2009. |
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10.40(8)*
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Termination Agreement between Stephan Rohaly and SCM Microsystems
GmbH dated September 30, 2009. |
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10.48
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Amended 2007 Stock Option Plan. |
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10.49(9)
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Business Combination Agreement, dated September 20, 2009, between
SCM Microsystems, Inc. and Bluehill ID AG. |
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10.50(10)
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Amendment to Business Combination Agreement, dated October 20, 2009,
between SCM Microsystems, Inc. and Bluehill ID AG. |
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31.1
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Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
of the Securities Exchange Act of 1934. |
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31.2
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Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
of the Securities Exchange Act of 1934. |
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32
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Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002. |
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(1) |
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Filed previously as an exhibit to SCMs Registration Statement on Form S-4/A dated November 10, 2009
(see SEC File No. 333-162618). |
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(2) |
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Filed previously as an exhibit to SCMs Registration Statement on Form S-1 (See SEC File No. 333-29073). |
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(3) |
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Filed previously as an exhibit to SCMs Quarterly Report on Form 10-Q for the quarter ended September
30, 2002 (see SEC File No. 000-22689). |
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(4) |
|
Filed previously as an exhibit to SCMs Registration Statement on Form 8-A (See SEC File No. 000-29440). |
|
(5) |
|
Filed previously as an exhibit to SCMs Quarterly Report on Form 10-Q for the quarter ended March 31,
2009 (see SEC File No. 000-29440). |
|
(6) |
|
Filed previously as an exhibit to SCMs Current Report on Form 8-K, dated April 29, 2009 (see SEC File
No. 000- |
60
|
|
|
|
|
29440). |
|
(7) |
|
Filed previously as an exhibit to SCMs Current Report on Form 8-K, dated April 8, 2009 (see SEC File
No. 000-29440). |
|
(8) |
|
Filed previously as an exhibit to SCMs Current Report on Form 8-K, dated September 30, 2009 (see SEC
File No. 000-29440). |
|
(9) |
|
Filed previously as an exhibit to SCMs Current Report on Form 8-K, dated September 21, 2009 (see SEC
File No. 000-29440). |
|
(10) |
|
Filed previously within Annex A of SCMs Form S4/A
Amended Registration Statement, dated November 12, 2009 (see SEC
File No. 333-162618). |
|
* |
|
Denotes management compensatory arrangement. |
61