e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 Q
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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 MARCH 31, 2008
OR
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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
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77-0444317 |
(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION)
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(I.R.S. EMPLOYER
IDENTIFICATION NUMBER) |
Oskar-Messter-Str. 13, 85737 Ismaning, Germany
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES INCLUDING ZIP CODE)
+ 49 89 95 95 5000
(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 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):
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Large accelerated filer
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Accelerated filer o |
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Non-accelerated filer o
(Do not check if a smaller reporting company) |
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Smaller reporting company
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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 May 5, 2008, 15,743,515 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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March 31, |
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2008 |
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2007 |
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Net revenue |
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$ |
6,464 |
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$ |
8,457 |
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Cost of revenue |
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3,781 |
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4,717 |
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Gross profit |
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2,683 |
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3,740 |
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Operating expenses: |
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Research and development |
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1,035 |
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720 |
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Selling and marketing |
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2,161 |
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1,559 |
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General and administrative |
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1,503 |
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1,400 |
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Amortization of intangible assets |
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175 |
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Total operating expenses |
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4,699 |
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3,854 |
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Loss from operations |
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(2,016 |
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(114 |
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Interest and other income, net |
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493 |
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308 |
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Income (loss) from continuing operations before income taxes |
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(1,523 |
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194 |
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Provision for income taxes |
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(47 |
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(60 |
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Income (loss) from continuing operations |
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(1,570 |
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134 |
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Loss from discontinued operations, net of income taxes |
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(125 |
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(17 |
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Gain on sale of discontinued operations, net of income taxes |
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13 |
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23 |
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Net income (loss) |
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$ |
(1,682 |
) |
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$ |
140 |
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Income (loss) per share from continuing operations: |
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Basic and diluted |
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$ |
(0.10 |
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$ |
0.01 |
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Loss per share from discontinued operations: |
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Basic and diluted |
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$ |
(0.01 |
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Net income (loss) per share: |
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Basic and diluted |
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$ |
(0.11 |
) |
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$ |
0.01 |
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Shares used to compute basic
income (loss) per share |
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15,741 |
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15,700 |
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Shares used to compute diluted
income (loss) per share |
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15,741 |
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15,742 |
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Comprehensive income (loss): |
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Net income (loss) |
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$ |
(1,682 |
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$ |
140 |
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Unrealized gain on investments |
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33 |
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10 |
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Foreign currency translation adjustment |
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337 |
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228 |
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Total comprehensive income (loss) |
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$ |
(1,312 |
) |
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$ |
378 |
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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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March 31, |
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December 31, |
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(in thousands) |
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2008 |
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2007 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
26,666 |
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$ |
18,600 |
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Short-term investments |
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1,988 |
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13,844 |
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Accounts receivable, net of allowances of $373 and
$341 as of March 31, 2008 and December 31, 2007,
respectively |
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9,263 |
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8,638 |
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Inventories |
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4,104 |
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2,738 |
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Other current assets |
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2,002 |
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1,455 |
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Total current assets |
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44,023 |
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45,275 |
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Property and equipment, net |
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1,486 |
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1,522 |
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Other assets |
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1,893 |
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1,767 |
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Total assets |
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$ |
47,402 |
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$ |
48,564 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Accounts payable |
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$ |
2,907 |
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$ |
3,063 |
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Accrued compensation and related benefits |
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1,348 |
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1,213 |
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Accrued restructuring and other charges |
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2,913 |
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2,960 |
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Accrued professional fees |
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916 |
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993 |
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Accrued royalties |
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424 |
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417 |
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Other accrued expenses |
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2,464 |
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2,325 |
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Income taxes payable |
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315 |
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277 |
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Total current liabilities |
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11,287 |
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11,248 |
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Deferred tax liability |
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87 |
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77 |
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Long-term income taxes payable |
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205 |
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200 |
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Commitments and contingencies (see Notes 10 and 11) |
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Stockholders equity: |
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Common stock, $0.001 par value: 40,000 shares
authorized; 16,362 and 16,356 shares issued and
15,744 and 15,737 shares outstanding as of March
31, 2008 and December 31, 2007, respectively |
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16 |
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16 |
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Additional paid-in capital |
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229,510 |
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229,414 |
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Treasury stock, 618 shares |
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(2,777 |
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(2,777 |
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Accumulated deficit |
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(193,771 |
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(192,089 |
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Accumulated other comprehensive income |
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2,845 |
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2,475 |
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Total stockholders equity |
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35,823 |
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37,039 |
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Total liabilities and stockholders equity |
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$ |
47,402 |
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$ |
48,564 |
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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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Three Months |
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Ended March 31, |
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2008 |
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2007 |
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Cash flows from operating activities: |
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Net income (loss) |
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$ |
(1,682 |
) |
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$ |
140 |
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Adjustments to reconcile net loss to net cash used in
operating activities: |
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Loss (gain) from discontinued operations |
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112 |
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(6 |
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Deferred income taxes |
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10 |
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2 |
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Depreciation and amortization |
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81 |
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244 |
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Loss (gain) on disposal of property and equipment |
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(6 |
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Stock compensation expense |
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77 |
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128 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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(324 |
) |
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498 |
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Inventories |
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(1,179 |
) |
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(886 |
) |
Other assets |
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147 |
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790 |
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Accounts payable |
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(327 |
) |
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(95 |
) |
Accrued expenses |
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(104 |
) |
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(1,283 |
) |
Income taxes payable |
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27 |
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42 |
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Net cash used in operating activities from continuing operations |
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(3,162 |
) |
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(432 |
) |
Net cash used in operating activities from discontinued operations |
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(826 |
) |
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(218 |
) |
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Net cash used in operating activities |
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(3,988 |
) |
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(650 |
) |
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Cash flows from investing activities: |
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Capital expenditures |
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(53 |
) |
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(101 |
) |
Maturities of short-term investments |
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11,890 |
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3,763 |
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Purchases of short-term investments |
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(3,940 |
) |
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Net cash provided by (used in) investing activities |
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11,837 |
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(278 |
) |
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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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74 |
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Net cash provided by financing activities |
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18 |
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74 |
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Effect of exchange rates on cash and cash equivalents |
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199 |
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204 |
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Net decrease in cash and cash equivalents |
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8,066 |
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(650 |
) |
Cash and cash equivalents at beginning of period |
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18,600 |
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32,103 |
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Cash and cash equivalents at end of period |
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$ |
26,666 |
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$ |
31,453 |
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Supplemental disclosures of cash flow information cash paid for: |
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Income taxes |
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$ |
8 |
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$ |
19 |
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See notes to condensed consolidated financial statements.
5
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2008
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 our financial position, results of
operations and cash flows have been included. Operating results for the three months ended March
31, 2008 are not necessarily indicative of the results that may be expected for the year ending
December 31, 2008 or any future period. For further information, refer to the financial statements
and notes thereto included in SCM Microsystems Inc.s (SCM or the Company) Annual Report on
Form 10-K for the year ended December 31, 2007. The preparation of our unaudited condensed
consolidated financial statements necessarily requires us 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.
Discontinued Operations
On May 22, 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 to
Kudelski S.A. (Kudelski) for a total consideration of $10.6 million in cash, of which $9 million
was paid at the time of sale and $1.6 million was paid in May 2007.
In accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting
for the Impairment or Disposal of Long Lived Assets, for the three months ended March 31, 2008 and
2007, this business has 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 3 for further discussion of this transaction.
Recent Accounting Pronouncements and Accounting Changes
In December 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 141
(revised 2007), Business Combinations (SFAS No. 141(R)). Under SFAS No. 141(R), 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 (IPR&D) is capitalized as an intangible asset and amortized
over its estimated useful life. The adoption of SFAS No. 141(R) will change our accounting
treatment for business combinations on a prospective basis beginning in the first quarter of fiscal
year 2009.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statementsan amendment of ARB No. 51. SFAS No. 160 changes the accounting and reporting
for minority interests, which will be recharacterized as non-controlling interests and classified
as a component of equity. SFAS No. 160 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
March 31, 2008, we did not have any minority interests.
On January 1, 2008, we adopted SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities Including an amendment of FASB Statement No. 115. SFAS No. 159 permits
companies to choose to measure certain financial instruments and other items at fair value using an
instrument-by-instrument election. The standard requires that unrealized gains and losses are
reported in earnings for items measured using the fair value option. The adoption of SFAS No. 159
did not have an impact on our consolidated financial position, results of operations and cash
flows.
6
On January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, for 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 (at least annually).
SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and enhances
fair value measurement disclosure. SFAS No. 157 does not change the accounting for those
instruments that were, under previous GAAP, accounted for at cost or contract value. The adoption
of SFAS No. 157 did not have a significant impact on our consolidated financial statements, and the
resulting fair values calculated under SFAS No. 157 after adoption were not significantly different
than the fair values that would have been calculated under previous guidance.
In February 2008, the FASB issued FASB Staff Position (FSP) 157-1, Application of FASB
Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements that Address Fair
Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, (FSP
157-1) and FSP 157-2, Effective Date of FASB Statement No. 157. FSP 157-1 amends SFAS No. 157 to
remove certain leasing transactions from its scope. FSP 157-2 delays the effective date of SFAS
No. 157 for all non-financial assets and non-financial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring basis (at least
annually), until the beginning of the first quarter of fiscal 2009. We are currently evaluating the
impact that SFAS No. 157 will have on our consolidated financial statements when it is applied to
non-financial assets and non-financial liabilities that are not measured at fair value on a
recurring basis beginning in the first quarter of 2009.
SFAS No. 157 establishes a fair value hierarchy that requires an entity to maximize the use of
observable inputs and minimize the use of unobservable inputs 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. SFAS No. 157 establishes three
levels of inputs that may be used to measure fair value:
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Level 1 Quoted prices for identical instruments in active markets; |
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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 |
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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 and
commercial papers) 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.
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 March 31, 2008 were as follows (in
thousands):
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Level 1 |
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Level 2 |
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Level 3 |
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Total |
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Money market fund deposits |
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$ |
15,020 |
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$ |
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$ |
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$ |
15,020 |
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Commercial papers |
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5,981 |
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5,981 |
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Corporate notes |
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|
1,988 |
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1,988 |
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Total: |
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$ |
22,989 |
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$ |
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$ |
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$ |
22,989 |
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As of March 31, 2008, there are no liabilities that are measured and recognized at fair value
on a recurring basis.
2. Stock Based Compensation
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
7
one year; some vesting 100% after one year; and some vesting
1/12th per month, commencing four years from the date of grant.
The Company previously had an Employee Stock Purchase Plan (ESPP) that allowed employees to
purchase shares of common stock at 85% of the fair market value at the lower of either the date of
enrolment or the date of purchase. Shares issued as a result of stock option exercises and
purchases under the Companys ESPP are newly issued shares. The Companys ESPP, Director Option
Plan and 1997 Stock Option Plan all expired in March 2007.
As of March 31, 2008, an aggregate of approximately 3.1 million shares of the Companys common
stock was reserved for future issuance under the Companys stock option plans, of which 1.8 million
shares were subject to outstanding options.
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 and shares issued under the ESPP included in the unaudited condensed consolidated statement
of operations for the three months ended March 31, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
Three months |
|
|
|
Ended March 31, |
|
|
|
2008 |
|
|
2007 |
|
Cost of revenue |
|
$ |
12 |
|
|
$ |
15 |
|
Research and development |
|
|
19 |
|
|
|
22 |
|
Selling and marketing |
|
|
55 |
|
|
|
30 |
|
General and administrative |
|
|
(9 |
) |
|
|
61 |
|
|
|
|
|
|
|
|
Stock-based compensation expense before income taxes |
|
$ |
77 |
|
|
$ |
128 |
|
Income tax benefit |
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
Stock-based compensation expense after income taxes |
|
$ |
77 |
|
|
$ |
128 |
|
|
|
|
|
|
|
|
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 March 31, 2008, a total of 1,331,555 shares of the Companys common stock are reserved for
future option grants under the 2000 Stock Option Plan and the 2007 Stock Option Plan.
8
A summary of the activity under the Companys stock option plans for the three months ended
March 31, 2008 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Average |
|
|
|
Options |
|
|
Number of |
|
|
Average |
|
|
Aggregate |
|
|
Remaining |
|
|
|
Available |
|
|
Options |
|
|
Exercise Price |
|
|
Intrinsic |
|
|
Contractual |
|
|
|
for Grant |
|
|
Outstanding |
|
|
per share |
|
|
Value |
|
|
Life (in years) |
|
Balance at December 31, 2007 |
|
|
1,493,493 |
|
|
|
1,862,272 |
|
|
$ |
10.97 |
|
|
$ |
191,809 |
|
|
|
5.77 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options granted |
|
|
(297,380 |
) |
|
|
297,380 |
|
|
$ |
3.13 |
|
|
|
|
|
|
|
|
|
Options cancelled or expired |
|
|
135,442 |
|
|
|
(385,624 |
) |
|
$ |
17.79 |
|
|
|
|
|
|
|
|
|
Options exercised |
|
|
|
|
|
|
(6,250 |
) |
|
$ |
2.93 |
|
|
$ |
1,507 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at March 31, 2008 |
|
|
1,331,555 |
|
|
|
1,767,778 |
|
|
$ |
8.20 |
|
|
$ |
0 |
|
|
|
6.26 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested or expected to vest
at March 31, 2008 |
|
|
|
|
|
|
1,590,285 |
|
|
$ |
8.73 |
|
|
$ |
0 |
|
|
|
6.09 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exerciseable at March 31, 2008 |
|
|
|
|
|
|
1,033,001 |
|
|
$ |
11.66 |
|
|
$ |
0 |
|
|
|
5.21 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted-average grant date fair value per option for options granted during the three
months ended March 31, 2008 and 2007 was $1.39 and $2.09, respectively. The total intrinsic value
of options exercised during the three months ended March 31, 2008 and 2007 was $1,500 and $750,
respectively. Cash proceeds from the exercise of stock options were $18,000 and $3,000 for the
three months ended March 31, 2008 and 2007, respectively. An income tax benefit of below $1,000 was
realized from stock option exercises during both three-month periods ended March 31, 2008 and 2007.
At March 31, 2008, there was $0.9 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 2.9 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 months ended March 31, 2008 and 2007,
respectively:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2008 |
|
2007 |
Expected volatility |
|
|
55 |
% |
|
|
60 |
% |
|
|
|
|
|
|
|
|
|
Dividend yield |
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
Risk-free interest rate |
|
|
2.15 |
% |
|
|
4.54 |
% |
|
|
|
|
|
|
|
|
|
Expected term (in years) |
|
|
4.00 |
|
|
|
4.00 |
|
Expected Volatility: The Companys computation of expected volatility for the three months
ended March 31, 2008 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 months ended
March 31, 2008 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.
9
Forfeitures Rate: Compensation expense recognized in the consolidated statement of operations
for the three-month periods ended March 31, 2008 and 2007 is based on awards ultimately expected to
vest and it reflects estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the
time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from
those estimates.
1997 Employee Stock Purchase Plan
Until its expiration in March 2007, the Companys ESPP permitted eligible employees to
purchase the Companys common stock through payroll deductions up to 10% of their base wages at a
purchase price of 85% of the lower of fair market value of the Companys common stock at the
beginning or end of each offering period. The Company had a two-year rolling plan with four
purchases every six months within the offering period. If the fair market value per share was lower
on the purchase date than the beginning of the offering period, the current offering period
terminated and a new two year offering period would have commenced. The Companys ESPP restricted
the maximum amount of shares purchased by an individual to $25,000 worth of the Companys common
stock each year. As of March 31, 2008, no shares were available for future issuance under the
Companys ESPP, due to the plans expiration in March 2007.
Stock-based compensation expense related to the Companys ESPP recognized under SFAS 123(R)
for the three months ended March 31, 2008 and 2007 was zero and a benefit of $40,000, respectively.
The benefit in the first three months of 2007 stemmed from the expiration of the plan before the
expected offering periods had terminated. At March 31, 2008, there was no further unrecognized
stock-based compensation expense related to outstanding ESPP shares as the plan expired in March
2007.
3. 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 million was paid at the time of sale and $1.6 million, which was
originally payable subject to the completion of certain product development milestones by Kudelski
subsequent to the close of the transaction, was paid in May 2007.
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived
Assets, for the three months ended March 31, 2008, the DTV solutions business has been presented as
discontinued operations in the unaudited 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.
Based on a Transition Services and Side Agreement between the Company and Kudelski, revenues
relating to the discontinued operations of the DTV solutions business were generated for a limited
time after the sale of the DTV solutions business. Under this agreement, a service fee was earned
by the Company for its services related to ordering products from a supplier and selling these
products to Kudelski. The agreement was terminated at the end of the first quarter of 2007 and
related revenues ceased to be generated after that period.
10
The operating results for the discontinued operations of the DTV solutions business for the
three months ended March 31, 2008 and 2007 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2008 |
|
2007 |
Net revenue |
|
$ |
|
|
|
$ |
496 |
|
|
|
|
|
|
|
|
|
|
Operating gain (loss) |
|
$ |
(4 |
) |
|
$ |
34 |
|
|
|
|
|
|
|
|
|
|
Income (loss) before income taxes |
|
$ |
(4 |
) |
|
$ |
57 |
|
|
|
|
|
|
|
|
|
|
Income tax benefit |
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
Gain (loss) from discontinued operations |
|
$ |
(4 |
) |
|
$ |
57 |
|
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 months ended March 31, 2008 and 2007 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2008 |
|
2007 |
Operating loss |
|
$ |
(82 |
) |
|
$ |
(80 |
) |
|
|
|
|
|
|
|
|
|
Net loss before income taxes |
|
$ |
(118 |
) |
|
$ |
(74 |
) |
|
|
|
|
|
|
|
|
|
Income tax provision |
|
$ |
(3 |
) |
|
$ |
|
|
|
|
|
|
|
|
|
|
|
Loss from discontinued operations |
|
$ |
(121 |
) |
|
$ |
(74 |
) |
11
4. Short-Term Investments
At March 31, 2008, the entire short-term investment portfolio matures in 2008. The fair value
of short-term investments at March 31, 2008 and December 31, 2007 was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31, 2008 |
|
|
|
|
|
|
Unrealized |
|
Unrealized |
|
Estimated |
|
|
Amortized |
|
Gain on |
|
Loss on |
|
Fair |
|
|
Cost |
|
Investments |
|
Investments |
|
Value |
Corporate notes |
|
$ |
1,983 |
|
|
$ |
5 |
|
|
$ |
|
|
|
$ |
1,988 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2007 |
|
|
|
|
|
|
Unrealized |
|
Unrealized |
|
Estimated |
|
|
Amortized |
|
Gain on |
|
Loss on |
|
Fair |
|
|
Cost |
|
Investments |
|
Investments |
|
Value |
Corporate notes |
|
$ |
13,872 |
|
|
$ |
|
|
|
$ |
(28 |
) |
|
$ |
13,844 |
|
The Company adopted SFAS No. 157, Fair Value Measurements, during the quarter ended March 31,
2008, see Note 1 Basis of Presentation for further discussion and explanation.
During each quarter, the Company evaluates its investments for possible asset impairment by
examining a number of factors, including the current economic conditions and markets for each
investment, as well as its cash position and anticipated cash needs for the short and long term. At
March 31, 2008, no position with an unrealized loss existed.
5. Inventories
Inventories consist of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
Raw materials |
|
$ |
1,559 |
|
|
$ |
1,202 |
|
Finished goods |
|
|
2,545 |
|
|
|
1,536 |
|
Total |
|
$ |
4,104 |
|
|
$ |
2,738 |
|
|
|
|
|
|
|
|
6. Property and Equipment
Property and equipment consists of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
Land |
|
$ |
140 |
|
|
$ |
142 |
|
Building and
leasehold improvements |
|
|
1,989 |
|
|
|
1,972 |
|
Furniture, fixtures and office equipment |
|
|
3,355 |
|
|
|
3,223 |
|
Automobiles |
|
|
34 |
|
|
|
35 |
|
Purchased software |
|
|
3,691 |
|
|
|
3,526 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
9,209 |
|
|
|
8,898 |
|
|
|
|
|
|
|
|
Accumulated depreciation |
|
|
(7,723 |
) |
|
|
(7,376 |
) |
|
|
|
|
|
|
|
Property and equipment, net |
|
$ |
1,486 |
|
|
$ |
1,522 |
|
|
|
|
|
|
|
|
12
Depreciation expense was $0.1 million for the three months ended March 31, 2008 and $0.1
million for the three months ended March 31, 2007, respectively.
7. Intangible Assets
Amortization expense related to intangible assets for continuing operations was zero for the
three months ended March 31, 2008, and $0.2 million for the three months ended March 31, 2007. No
further amounts remain to be amortized in future periods.
8. Restructuring and Other Charges
Continuing Operations
In the three months ended March 31, 2008 and 2007, the Company incurred $0 restructuring and
other charges related to continuing operations.
Accrued liabilities related to restructuring actions and other activities during the three
months ended March 31, 2008 and during the year ended December 31, 2007 consist of the following
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease/Contract |
|
|
|
|
|
|
|
|
|
|
|
|
Commitments |
|
|
Severance |
|
|
Other Costs |
|
|
Total |
|
Balances as of January 1, 2007 |
|
$ |
15 |
|
|
$ |
106 |
|
|
$ |
9 |
|
|
$ |
130 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
|
|
|
|
(4 |
) |
|
|
|
|
|
|
(4 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4 |
) |
|
|
|
|
|
|
(4 |
) |
Payments and other changes in 2007 |
|
|
(3 |
) |
|
|
(102 |
) |
|
|
1 |
|
|
|
(104 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances as of December 31, 2007 |
|
|
12 |
|
|
|
|
|
|
|
10 |
|
|
|
22 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for Q1 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments and other changes in Q1 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances as of March 31, 2008 |
|
$ |
12 |
|
|
$ |
|
|
|
$ |
10 |
|
|
$ |
22 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discontinued Operations
In the first three months of 2008 and 2007, income from restructuring and other items related
to discontinued operations was approximately $19,000 and $13,000, respectively.
Accrued liabilities related to the Digital Media and Video restructuring actions and other
activities during the first three months of 2008 and during the year ended December 31, 2007
consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease/Contract |
|
|
|
|
|
|
|
|
|
Commitments |
|
|
Other Costs |
|
|
Total |
|
Balances as of January 1, 2007 |
|
$ |
2,949 |
|
|
$ |
352 |
|
|
$ |
3,301 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
(70 |
) |
|
|
(40 |
) |
|
|
(110 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(70 |
) |
|
|
(40 |
) |
|
|
(110 |
) |
Payments and other changes in 2007 |
|
|
(290 |
) |
|
|
37 |
|
|
|
(253 |
) |
|
|
|
|
|
|
|
|
|
|
Balances as of December 31, 2007 |
|
|
2,589 |
|
|
|
349 |
|
|
|
2,938 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for Q1 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
(19 |
) |
|
|
|
|
|
|
(19 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(19 |
) |
|
|
|
|
|
|
(19 |
) |
Payments and other changes in Q1 2008 |
|
|
(54 |
) |
|
|
26 |
|
|
|
(28 |
) |
|
|
|
|
|
|
|
|
|
|
Balances as of March 31, 2008 |
|
$ |
2,516 |
|
|
$ |
375 |
|
|
$ |
2,891 |
|
|
|
|
|
|
|
|
|
|
|
13
In April 2008, the Company entered into an agreement to terminate its lease agreement for the
premises leased in the UK (see Note 13 to the financial statements for further discussion). In the
second quarter of 2008, the Company recorded a gain of approximately $0.4 million in connection
with the termination of this lease agreement.
9. Segment Reporting, Geographic Information and Major Customers
SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, 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 maker is considered to be its executive staff, consisting of the Chief Executive
Officer; Chief Financial Officer; Executive Vice President, Strategic Sales and Business
Development and Executive Vice President, Strategy, Marketing and Engineering.
The Companys continuing operations provide secure digital access solutions to original
equipment manufacturers, or OEM customers in two markets segments: PC Security and Digital Media
Readers. 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 segments for management
purposes.
Summary information by segment for the three months ended March 31, 2008 and 2007 is as
follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, |
|
|
2008 |
|
2007 |
PC Security: |
|
|
|
|
|
|
|
|
Net revenue |
|
$ |
5,007 |
|
|
$ |
7,096 |
|
Gross profit |
|
|
2,147 |
|
|
|
3,243 |
|
Gross profit % |
|
|
43 |
% |
|
|
46 |
% |
|
|
|
|
|
|
|
|
|
Digital Media Readers: |
|
|
|
|
|
|
|
|
Net revenue |
|
$ |
1,457 |
|
|
$ |
1,361 |
|
Gross profit |
|
|
536 |
|
|
|
497 |
|
Gross profit % |
|
|
37 |
% |
|
|
37 |
% |
|
|
|
|
|
|
|
|
|
Total: |
|
|
|
|
|
|
|
|
Net revenue |
|
$ |
6,464 |
|
|
$ |
8,457 |
|
Gross profit |
|
|
2,683 |
|
|
|
3,740 |
|
Gross profit % |
|
|
42 |
% |
|
|
44 |
% |
14
Geographic net revenue is based on selling location. Information regarding net revenue by
geographic region is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
Net revenue
|
|
|
|
|
|
|
|
|
Europe |
|
$ |
2,390 |
|
|
$ |
2,408 |
|
United States |
|
|
2,111 |
|
|
|
3,799 |
|
Asia-Pacific |
|
|
1,963 |
|
|
|
2,250 |
|
|
|
|
|
|
|
|
Total |
|
$ |
6,464 |
|
|
$ |
8,457 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% of net revenue |
|
|
|
|
|
|
|
|
Europe |
|
|
37 |
% |
|
|
28 |
% |
United States |
|
|
33 |
% |
|
|
45 |
% |
Asia-Pacific |
|
|
30 |
% |
|
|
27 |
% |
Long-lived assets by geographic location as of March 31, 2008 and December 31, 2007, are as
follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
Property and equipment, net: |
|
|
|
|
|
|
|
|
United States |
|
$ |
11 |
|
|
$ |
14 |
|
Europe |
|
|
177 |
|
|
|
171 |
|
Asia-Pacific |
|
|
1,298 |
|
|
|
1,337 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,486 |
|
|
$ |
1,522 |
|
|
|
|
|
|
|
|
10. Commitments
The Company leases its facilities, certain equipment, and automobiles under noncancelable
operating lease agreements. Those lease agreements existing as of March 31, 2008 expire at various
dates during the next nine years.
As a result of the termination of the lease contract for the premises leased in the UK, the
future minimum lease payments during the next nine years will be reduced by $2.0 million (See Note
13 Subsequent Events for further explanation).
Purchases for inventories are highly dependent upon forecasts of the customers 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 March 31, 2008, total purchase and
contractual commitments were approximately $5.1 million.
The Company 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. The Company 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 the Companys estimates, adjustments to recognize additional cost of
sales may be required in future periods.
15
Components of the reserve for warranty costs for the three months ended March 31, 2008 and
2007 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
|
2007 |
|
Balances at January 1, |
|
$ |
36 |
|
|
$ |
34 |
|
Additions related to sales during the period |
|
|
12 |
|
|
|
17 |
|
Warranty costs incurred during the period |
|
|
(8 |
) |
|
|
(16 |
) |
Adjustments to accruals related to prior period sales |
|
|
(10 |
) |
|
|
2 |
|
|
|
|
|
|
|
|
Balances at March 31, |
|
$ |
30 |
|
|
$ |
37 |
|
|
|
|
|
|
|
|
11. 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 |
|
|
|
March 31, |
|
|
|
2008 |
|
|
2007 |
|
Net income (loss) from continuing operations |
|
$ |
(1,570 |
) |
|
$ |
134 |
|
Net Income (loss) from discontinued operations |
|
|
(112 |
) |
|
|
6 |
|
|
|
|
|
|
|
|
Net income (loss) |
|
$ |
(1,682 |
) |
|
$ |
140 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in income (loss) per common share basic |
|
|
15,741 |
|
|
|
15,700 |
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
Employee and director stock options |
|
|
0 |
|
|
|
42 |
|
|
|
|
|
|
|
|
Shares used in income (loss) per common share diluted |
|
|
15,741 |
|
|
|
15,742 |
|
Net income (loss) per common share basic and diluted |
|
|
|
|
|
|
|
|
Continuing operations |
|
$ |
(0.10 |
) |
|
$ |
0.01 |
|
Discontinued operations |
|
$ |
(0.01 |
) |
|
$ |
0.00 |
|
|
|
|
|
|
|
|
Net income (loss) per common share basic and diluted |
|
$ |
(0.11 |
) |
|
$ |
0.01 |
|
|
|
|
|
|
|
|
The computation of diluted net loss per common share for the three months ended March 31,
2008, excludes the effect of the potential exercise of options to purchase approximately 11,000
shares, 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 months ended March 31, 2008, also
excludes the effect of the potential exercise of options to purchase approximately 1.8 million
shares, because the option exercise price was greater than the average market price of the common
shares and the effect would have been anti-dilutive.
The computation of diluted net income per common share for the three months ended March 31,
2007, excludes the effect of the potential exercise of options to purchase approximately 1.6
million shares, because the option exercise price was greater than the average market price of the
common shares and the effect would have been anti-dilutive.
16
12. Legal Proceedings
From time to time, the Company could be subject to claims arising in the ordinary course of
business or be 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.
13. Subsequent Events
In April 2008, the Company entered into an agreement to terminate its lease agreement for
premises leased in the UK. A termination payment and related transaction costs of approximately
$0.5 million was incurred and the related restructuring accruals of approximately $0.9 million were
released in the second quarter of 2008. The transaction resulted in a net gain of approximately
$0.4 million from discontinued operations in the second quarter of 2008.
17
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, 2007.
Overview
SCM Microsystems, Inc. (SCM, the Company, we and us) was incorporated in 1996 under
the laws of the state of Delaware. We design, develop and sell hardware, software and silicon
solutions that enable people to conveniently and securely access digital content and services. We
sell our secure digital access products in two market segments: PC Security and Digital Media
Readers.
|
|
|
For the PC Security market, we offer smart card reader technology that enables
authentication of individuals for applications such as electronic passports and drivers
licenses, electronic healthcare cards, secure logical access to PCs and networks, and
physical access to facilities. Within the PC Security segment, we also offer a line of
smart card solutions under the CHIPDRIVE® brand that include productivity applications such
as time recording and attendance, physical access and password management for small and
medium sized enterprises. |
|
|
|
|
For the Digital Media Reader market, we offer digital media readers that are used to
transfer digital content to and from various flash media. These readers are primarily used
in digital photo kiosks. |
We sell our products primarily to original equipment manufacturers, or OEMs, who typically
either bundle our products with their own solutions, or repackage our products for resale to their
customers. Our OEM customers include: government contractors, systems integrators, large
enterprises and computer manufacturers, as well as banks and other financial institutions for our
smart card readers; and computer and photo processing equipment manufacturers for our digital media
readers. We sell and license our products through a direct sales and marketing organization, as
well as through distributors, value added resellers and systems integrators worldwide.
On May 22, 2006, we completed the sale of our Digital Television solutions (DTV solutions)
business to Kudelski S.A. As a result, we have accounted for the DTV solutions business as a
discontinued operation, and the statements of operations and cash flows for all periods presented
reflect the discontinuance of this business. In addition, our operations previously included a
retail Digital Media and Video business, which we sold in the third quarter of 2003. As a result of
this sale and divestiture, beginning in the second quarter of fiscal 2003, we have accounted for
the retail Digital Media and
18
Video business as a discontinued operation, and statements of operations for all periods
presented reflect the discontinuance of this business. (See Note 3 to Condensed Consolidated
Financial Statements of this Form 10-Q.)
Throughout most of 2007, our revenue growth strategy was primarily based on the introduction
of new PC Security products to address emerging smart card-based security programs in Europe,
including e-passport, national ID and e-health. Additionally, we implemented programs to expand
sales of our CHIPDRIVE time recording solutions to markets outside Germany. We also continued our
traditional focus on the U.S. government market, providing smart card readers for authentication
programs within various federal agencies; as well as providing digital media readers for the photo
kiosk market in the U.S.
During 2007, we experienced sustained demand for our smart card readers and we experienced
increased demand for our digital media readers in three of our four quarters. Order delays across
our business reduced revenue levels in the second quarter of 2007. In recent months, we have
experienced weaker demand for our smart card readers from the U.S. government sector, due, we
believe, to a reduced level of overall activity in the market. In the first quarter of 2008, this
resulted in a significant reduction in our PC Security and overall revenues.
In late 2007, we began to implement a new growth strategy that aims to expand sales of
existing product lines into new geographic markets and to diversify and expand our customer base.
We have added sales resources in Latin America, Asia, Europe and the U.S. to increase our ability
to address current and future business opportunities. For example, we have recently added sales
resources to targeting authentication programs in the government and enterprise sectors in Latin
America and Asia, and we have recently begun targeting the photo kiosk markets in Europe and Asia.
We have also initiated business development activities aimed at penetrating the worldwide financial
services and enterprise markets with new contactless reader products.
Additionally, in late 2007 and in early 2008, we reorganized and strengthened our management
team with key executive hires and promotions. Felix Marx joined as Chief Executive Officer in
October 2007; Sour Chhor joined as Executive Vice President, Strategy, Marketing and Engineering in
February 2008; and Manfred Mueller was promoted to Executive Vice President, Strategic Sales and
Business Development in March 2008. We believe our new executives and the new structure of our
executive team strengthen our ability to anticipate and respond to market trends in our industry.
In both our PC Security and Digital Media Reader businesses, pricing pressure has continued
over the last several quarters. To counter this trend, in late 2006, we implemented cost reduction
programs that have resulted in improvements to our product margins. We believe we can continue to
offset pricing pressure and material cost increases with ongoing improvements in our supply chain
systems.
In our continuing operations, we may experience significant variations in demand for our
products quarter to quarter. This is particularly true for our PC Security products, the majority
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.
Sales of our Digital Media Reader products are less subject to this variability based on market or
project demands; however, we are dependent on a small number of customers in both of our primary
product segments, which can result in fluctuations in sales levels from one period to another.
19
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
accounting principles generally accepted in the United States of America (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 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, affect 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 is highly unpredictable and can fluctuate substantially. We
regularly review inventory quantities on hand and record an estimated provision for excess
inventory, technical obsolescence and no sale-ability 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. Excess inventory frequently remains saleable. When excess
inventory is sold, it yields a gross profit margin of up to 100%. Sales of excess
inventory have the effect of increasing the gross profit margin beyond that which would
otherwise occur, because of previous write-downs. Once we have written down inventory
below cost, we do not subsequently write it up. |
|
|
|
|
We adopted the Financial Accounting Standards Boards (FASB) Interpretation No. 48,
Accounting For Uncertain Tax Positions (FIN 48) in the first quarter of 2007. 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. FIN 48 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. At
March 31, 2008, we have recorded valuation allowances against all of our deferred tax
assets. 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. |
20
|
|
|
We accrue the estimated cost of product warranties during the period of sale. While
we engage in extensive product quality programs and processes, including actively
monitoring and evaluating the quality of our component suppliers, our warranty obligation
is affected by actual warranty costs, including material usage or service delivery costs
incurred in correcting a product failure. If actual material usage or service delivery
costs differ from our estimates, revisions to our estimated warranty liability would be
required, which could have a material impact on our results of operations. |
|
|
|
|
During previous years, we have recorded restructuring charges as we rationalized
operations in light of strategic decisions to align our business focus on certain markets.
These measures, which included major changes in senior management, workforce reduction,
facilities consolidation and the transfer of our production to contract manufacturers,
were largely intended to align our capacity and infrastructure to anticipate customer
demand and to transition our operations to better cost efficiencies. In connection with
plans we have adopted, we recorded estimated expenses for severance and outplacement
costs, lease cancellations, asset write-offs and other restructuring costs. Statement of
Financial Accounting Standard (SFAS) No. 146, Accounting for Costs Associated with Exit
or Disposal Activities, requires that a liability for a cost associated with an exit or
disposal activity initiated after December 31, 2002 be recognized when the liability is
incurred and that the liability be measured at fair value. Given the significance of, and
the timing of the execution of such activities, this process is complex and involves
periodic reassessments of original estimates. We continually evaluate the adequacy of the
remaining liabilities under our restructuring initiatives. Although we believe that these
estimates accurately reflect the costs of our restructuring and other plans, actual
results may differ, thereby requiring us to record additional provisions or reverse a
portion of such provisions. |
Recent Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS
No.141(R)). Under SFAS No. 141(R), 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 impact income tax
expense. In addition, acquired in-process research and development (IPR&D) is capitalized as an
intangible asset and amortized over its estimated useful life. The adoption of SFAS No. 141(R) will
change our accounting treatment for business combinations on a prospective basis beginning in the
first quarter of fiscal year 2009.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statementsan amendment of ARB No. 51. SFAS No. 160 changes the accounting and reporting
for minority interests, which will be recharacterized as non-controlling interests and classified
as a component of equity. SFAS No. 160 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
March 31, 2008, we did not have any minority interests.
On January 1, 2008, we adopted SFAS No. 159, The Fair Value Option for Financial Assets and
Financial LiabilitiesIncluding an amendment of FASB Statement No. 115. SFAS No. 159 permits
companies to choose to measure certain financial instruments and other items at fair value using an
instrument-by-instrument election. The standard requires that unrealized gains and losses are
reported in earnings for items measured using the fair value option. The adoption of SFAS No. 159
did not have an impact on our consolidated financial position, results of operations and cash
flows.
On January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, for 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 (at least annually).
SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and enhances
fair value measurement disclosure. SFAS No. 157 does not change the accounting for those
instruments that were, under previous GAAP, accounted for at cost or contract value. The adoption
of SFAS No. 157 did not have a significant impact on our consolidated financial statements, and the
resulting fair values calculated under SFAS No. 157 after adoption were not significantly different
than the fair values that would have been calculated under previous guidance.
21
In February 2008, the FASB issued FASB Staff Position (FSP) 157-1, Application of FASB
Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements that Address Fair
Value Measurements for Purposes of Lease Classification or Measurement under Statement 13 (FSP
157-1) and FSP 157-2, Effective Date of FASB Statement No. 157. FSP 157-1 amends SFAS No. 157 to
remove certain leasing transactions from its scope. FSP 157-2 delays the effective date of SFAS
No. 157 for all non-financial assets and non-financial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring basis (at least
annually), until the beginning of the first quarter of fiscal 2009. We are currently evaluating the
impact that SFAS No. 157 will have on our consolidated financial statements when it is applied to
non-financial assets and non-financial liabilities that are not measured at fair value on a
recurring basis beginning in the first quarter of 2009.
SFAS No. 157 establishes a fair value hierarchy that requires an entity to maximize the use of
observable inputs and minimize the use of unobservable inputs 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. SFAS No. 157 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 and
commercial papers) 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.
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 March 31, 2008 were as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
|
Total |
|
Money market fund deposits |
|
$ |
15,020 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
15,020 |
|
Commercial papers |
|
|
5,981 |
|
|
|
|
|
|
|
|
|
|
|
5,981 |
|
Corporate notes |
|
|
1,988 |
|
|
|
|
|
|
|
|
|
|
|
1,988 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total: |
|
$ |
22,989 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
22,989 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of March 31, 2008, there are no liabilities that are measured and recognized at fair value
on a recurring basis.
22
Results of Operations
Net Revenue. Summary information by product segment for the three months ended March 31, 2008
and 2007 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% change |
|
|
Three months ended |
|
period to |
|
|
March 31, |
|
period |
|
|
2008 |
|
2007 |
|
|
|
|
PC Security |
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
5,007 |
|
|
$ |
7,096 |
|
|
|
(29 |
)% |
Gross profit |
|
|
2,147 |
|
|
|
3,243 |
|
|
|
|
|
Gross profit % |
|
|
43 |
% |
|
|
46 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Digital Media Readers |
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
1,457 |
|
|
$ |
1,361 |
|
|
|
7 |
% |
Gross profit |
|
|
536 |
|
|
|
497 |
|
|
|
|
|
Gross profit % |
|
|
37 |
% |
|
|
37 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total: |
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
6,464 |
|
|
$ |
8,457 |
|
|
|
(24 |
)% |
Gross profit |
|
|
2,683 |
|
|
|
3,740 |
|
|
|
|
|
Gross profit % |
|
|
42 |
% |
|
|
44 |
% |
|
|
|
|
Net revenue for the first quarter of 2008 was $6.5 million, down 24% compared to $8.5 million
for the same period of 2007. This decrease in revenue resulted from lower sales of our PC Security
products that were only partially offset by higher sales of our Digital Media Reader products.
Our PC Security product line principally consists of smart card readers and related chip
technology that are primarily used in large security programs where smart cards 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. Also included in this
business segment are 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 PC Security business segment is government, financial or
enterprise programs and is subject to significant variability based on the size and timing of
customer orders.
Sales of our PC Security products were $5.0 million in the first quarter of 2008, down 29%
from sales of $7.1 million in the first quarter of 2007. The decrease in sales between the two
periods was primarily due to a significant reduction in sales of our smart card reader products for
U.S. government authentication programs, as a result of slower than expected project deployment
schedules and overall weaker demand from this market. We sold higher than usual volumes of smart
card interface chips to laptop and keyboard manufacturers in Asia in the first quarter of 2008.
Sales of smart card reader products in Europe remained stable.
Our Digital Media Reader product line consists 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 approximately two-thirds of sales in this business
segment. As a result, revenue in our Digital Media Reader product line can fluctuate significantly
quarter to quarter due to variability in the size and timing of customer orders.
Sales of our Digital Media Reader products were $1.5 million in the first quarter of 2008, an
increase of 7% from sales of $1.4 million in the same period of 2007. During the first quarter of
2008, we began to experience lower order levels from a significant customer as they prepare to
introduce a new photo kiosk model which will utilize a different version of our media readers.
Gross Profit. Gross profit for the first quarter of 2008 was $2.7 million, or 42% of revenue,
compared with $3.7 million, or 44% of revenue in the first quarter of 2007.
23
Gross profit for our PC Security products was 43% for the first quarter of 2008, compared with
46% for the first quarter of 2007. The decrease in gross profit in the first quarter of 2008
compared with the same period of 2007 was primarily due to lower revenue levels, and therefore
relatively higher fixed costs, in the first quarter of 2008.
Gross profit for our Digital Media Reader products was 37% for the first quarter of 2008,
unchanged from 37% for the first quarter of 2007.
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.
Research and Development.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% change |
|
|
Three months ended March 31, |
|
period to |
(in thousands) |
|
2008 |
|
2007 |
|
period |
|
|
|
Expenses |
|
$ |
1,035 |
|
|
$ |
720 |
|
|
|
44 |
% |
Percentage of total revenues |
|
|
16 |
% |
|
|
9 |
% |
|
|
|
|
Research and development expenses consist primarily of employee compensation and fees for the
development of hardware and firmware products.
We focus the bulk of our research and development activities on the development of products
for new and emerging market opportunities. Research and development expenses were $1.0 million in
the first quarter of 2008, or 16% of revenue, compared with $0.7 million in the first quarter of
2007, or 9% of revenue, an increase of 44%. This increase was primarily related to the development
of a new contactless USB dongle for financial and enterprise applications, as well as to increased
development activity related to readers for the German e-health program.
We expect our research and development expenses to vary based on future project demands and on
the markets we target.
Selling and Marketing.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% change |
|
|
Three months ended March 31, |
|
period to |
(in thousands) |
|
2008 |
|
2007 |
|
period |
|
|
|
Expenses |
|
$ |
2,161 |
|
|
$ |
1,559 |
|
|
|
39 |
% |
Percentage of total revenues |
|
|
33 |
% |
|
|
18 |
% |
|
|
|
|
Selling and marketing expenses consist primarily of employee compensation as well as tradeshow
participation and other marketing costs. We focus a significant proportion of our sales and
marketing activities on new and emerging market opportunities, including government authentication,
e-health, financial services and the market for time recording solutions for small- and
medium-sized businesses. Selling and marketing expenses were $2.2 million in the first quarter of
2008, or 33% of revenue, compared with $1.6 million in the first quarter of 2007, or 18% of
revenue, an increase of 39%. The increase was primarily due to the hiring of new sales resources
over the past two quarters in Latin America, Asia, Europe and the U.S. to enhance our ability to
address current and future business opportunities, as well as an increased level of travel expenses
related to new business development activities.
General and Administrative.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% change |
|
|
Three months ended March 31, |
|
period to |
(in thousands) |
|
2008 |
|
2007 |
|
period |
|
|
|
Expenses |
|
$ |
1,503 |
|
|
$ |
1,400 |
|
|
|
7 |
% |
Percentage of total revenues |
|
|
23 |
% |
|
|
17 |
% |
|
|
|
|
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.
In the first quarter of 2008, general and administrative expenses were $1.5 million, or 23% of
revenue, compared with $1.4 million, or 17% of revenue in the first quarter of 2007, an increase of
7%. The increase was primarily due to the
24
devaluation of the dollar against foreign currencies, namely the Euro, as we pay the majority
of general and administrative expenses in local currency but account for those expenses in dollars.
Amortization of Intangibles. Amortization of intangibles was zero during the first quarter of
2008, compared with $0.2 million during the first quarter of 2007. No further amounts remain to be
amortized in future periods as the intangible assets have been fully amortized.
Interest and other Income, net. Interest and other income, net consists of interest earned on
invested cash and foreign currency gains or losses. In the first quarter of 2008, interest income
resulting from invested cash balances was $0.3 million, compared with interest income of $0.4
million in the first quarter of 2007. Foreign currency gains were $0.2 million in the first quarter
of 2008 compared to foreign currency losses of $0.1 million in the first quarter of 2007.
Income Taxes. In the first quarter of 2008, we recorded a provision for income taxes of
$47,000, primarily for minimum taxation and taxes payable in foreign jurisdictions that were not
offset by operating loss carryforwards. The provision for income taxes of $60,000 during the first
quarter of 2007 related primarily to minimum taxation and other taxes payable that could not be
offset with operating 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 in the first quarter of 2008 and 2007 was zero and $0.5
million, respectively. Operating loss for the DTV solutions business in the first quarter of 2008
was $4,000, compared to an operating gain of $34,000 in the first quarter of 2007.
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 the first
quarter of each of 2008 and 2007. Operating loss for the retail Digital Media and Video business
was $0.1 million in the first quarter of each of 2008 and 2007.
During the first quarter of 2008 and 2007, net gain on the disposal of discontinued operations
was approximately $13,000 and $23,000, respectively.
Liquidity and Capital Resources
As of March 31, 2008, our working capital, which we have defined as current assets less
current liabilities, was $32.7 million, compared to $34.0 million as of December 31, 2007, a
decrease of approximately $1.3 million. The reduction in working capital for the first three months
of 2008 primarily reflects lower cash and cash equivalents and short-term investments of $3.7
million, partly offset by a $2.5 million increase from the combined development of accounts
receivable, inventories and other current assets while current liabilities have remained nearly
unchanged.
Cash and cash equivalents and short-term investments were $28.7 million as of March 31, 2008,
a decrease of approximately $3.7 million compared to the balance of $32.4 million as of December
31, 2007.
The following summarizes our cash flows for the three months ended March 31, 2008 (in
thousands):
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2008 |
|
Operating cash used in continuing operations |
|
$ |
(3,162 |
) |
Operating cash used in discontinued operations |
|
|
(826 |
) |
Investing cash provided |
|
|
11,837 |
|
Financing cash flow |
|
|
18 |
|
Effect of exchange rate changes on cash and cash equivalents |
|
|
199 |
|
|
|
|
|
|
|
|
|
|
Increase in cash and cash equivalents |
|
|
8,066 |
|
Cash and cash equivalents at beginning of period |
|
|
18,600 |
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
26,666 |
|
|
|
|
|
During the first three months of 2008, cash used in operating activities was $4.0 million.
This use of cash consisted of a net loss of $1.7 million, the cash use of approximately $1.8
million from net changes in operating assets and liabilities and
25
the cash use of approximately $0.7
million from the net changes in the assets and liabilities from discontinued operations partially
offset by cash flow adjustments for depreciation, amortization and stock compensation totaling $0.2
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 March 31, 2008. As
a result of the agreement to terminate our lease contract for the UK during the second quarter of
2008, the future minimum lease payments during the next nine years will be reduced by $2.0 million
(see Note 13 to the financial statements for further explanation). Inventory and other purchase
commitments were approximately $5.1 million at March 31, 2008.
We currently expect that our current capital resources and available borrowings should be
sufficient to meet our operating and capital requirements through at least the end of 2008. 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.
Cash provided from investing activities for the three months ended March 31, 2008, was
primarily from the maturity of short-term investments of $11.9 million.
26
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no significant change in our exposure to market risk during the first three
months of 2008. For discussion of SCMs exposure to market risk, refer to Item 7A, Quantitative
and Qualitative Disclosures About Market Risk, contained in the Companys Annual Report
incorporated by reference in Form 10-K for the year ended December 31, 2007.
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our chief
executive officer (CEO) and chief financial officer (CFO), we conducted an evaluation of the
effectiveness of the design and operation of our disclosure controls and procedures, as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of March
31, 2008. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and
procedures were effective as of March 31, 2008, such that the information relating to our business
and operations, including our consolidated subsidiaries, required to be disclosed in our Securities
and Exchange Commission (SEC) reports (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.
(b) Changes in Internal Controls over Financial Reporting
In connection with our continued monitoring and maintenance of our controls procedures in
relation to the provisions of Sarbanes-Oxley, 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 15d-15(e) under the Securities Exchange Act of 1934,
as amended, during the first quarter of 2008 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.
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, SCM could be subject to claims arising in the ordinary course of business
or be a defendant in lawsuits. While the outcome of such claims or other proceedings cannot be
predicted with certainty, SCMs 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 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 following risk factors 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
27
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.
We have incurred operating losses and may not achieve profitability.
We have a history of losses with an accumulated deficit of $193.8 million as of March 31,
2008. 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.
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. Our revenues, gross profit and operating results may fluctuate significantly from quarter
to quarter due to, among other things:
|
|
|
business and economic conditions overall and in our markets; |
|
|
|
|
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; |
|
|
|
|
cancellations or delays of customer product orders, or the loss of a significant
customer; |
|
|
|
|
our ability to obtain an adequate supply of components on a timely basis; |
|
|
|
|
poor quality in the supply of our components; |
|
|
|
|
delays in the manufacture of our products; |
|
|
|
|
the absence of significant backlog in our business; |
|
|
|
|
our inventory levels; |
|
|
|
|
our customer and distributor inventory levels and product returns; |
|
|
|
|
competition; |
|
|
|
|
new product announcements or introductions; |
|
|
|
|
our ability to develop, introduce and market new products and product enhancements on
a timely basis, if at all; |
|
|
|
|
our ability to successfully market and sell products into new geographic or market
segments; |
|
|
|
|
the sales volume, product configuration and mix of products that we sell; |
|
|
|
|
technological changes in the markets for our products; |
|
|
|
|
the rate of adoption of industry-wide standards; |
|
|
|
|
reductions in the average selling prices that we are able to charge due to
competition or other factors; |
|
|
|
|
strategic acquisitions, sales and dispositions; |
|
|
|
|
fluctuations in the value of foreign currencies against the U.S. dollar; |
|
|
|
|
the timing and amount of marketing and research and development expenditures; |
|
|
|
|
loss of key personnel; and |
|
|
|
|
costs related to events such as dispositions, organizational restructuring, headcount
reductions, litigation or write-off of investments. |
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
28
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.
It is difficult to estimate operating results prior to the end of a quarter.
We do not typically maintain a significant level of backlog. As a result, revenue in any
quarter depends on contracts entered into or orders booked and shipped in that quarter.
Historically, many of our 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. This trend makes predicting revenues difficult. 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.
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 a significant volume 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 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.
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:
|
|
|
low volumes of trading activity in our stock, particular in the U.S.; |
|
|
|
|
variations in our or our competitors financial and/or operational results; |
|
|
|
|
the fluctuation in market value of comparable companies in any of our markets; |
|
|
|
|
expected, perceived or announced relationships or transactions with third parties; |
|
|
|
|
comments and forecasts by securities analysts; |
|
|
|
|
trading patterns of our stock on the NASDAQ Stock Market or Prime Standard of the
Frankfurt Stock Exchange; |
|
|
|
|
the inclusion or removal of our stock from market indices, such as groups of
technology stocks or other indices; |
|
|
|
|
loss of key personnel; |
|
|
|
|
announcements of technological innovations or new products by us or our competitors; |
|
|
|
|
announcements of dispositions, organizational restructuring, headcount reductions,
litigation or write-off of investments; |
|
|
|
|
litigation developments; and |
|
|
|
|
general market downturns. |
29
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.
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 OEM customers in the consumer electronics, digital
photo processing and computer industries, as well as the government 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
58% of revenue in the first three months of 2008 and 61% of revenue in fiscal year 2007. 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
Reader 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 half of 2007, we experienced a significant reduction in sales of our Digital
Media Reader products due to the loss of a 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.
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. In recent
months we have also focused on expanding sales of existing product lines into new geographic
markets and diversifying and expanding our customer base. For example, we have recently added sales
resources to target authentication programs in the government and enterprise sectors in Latin
America and Asia, and have recently begun to target the photo kiosk markets in Europe and Asia. We
have also 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. For example, in the second quarter of 2007, we experienced lower sales of our PC Security
products in Europe in part as a result of delays in the timing of orders for several smart card
programs. There is no assurance that demand will become more predictable as additional smart card
programs demonstrate success. 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 the size or
composition of the market for any of our products. Our target markets have not consistently grown
or developed as quickly as we had 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; |
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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; |
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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 ability of financial institutions, corporate enterprises, the U.S. government and
other governments to agree on industry specifications and to develop and deploy security
applications that will drive demand for reader solutions 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. |
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.
Products such as our smart card readers and digital media readers 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 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 PC Security 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.
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.
Our business could suffer if our third-party manufacturers cannot meet production requirements.
Our products are manufactured outside the United States by contract manufacturers. 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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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
or are unwilling to produce the quantities we desire; and |
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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 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 two suppliers to produce our ASICs for smart
cards readers, and we use chips and antenna components from one supplier in our contactless smart
card readers. 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. In addition, some of the basic components we use in our products, such
as digital flash media, may at any time be in great demand. This could result in components not
being available to us in a timely manner or at all, particularly if larger companies have ordered
more significant volumes of those components, or in higher prices being charged for components.
Disruption or termination of the supply of components or software used in our products could delay
shipments of these 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.
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. For example, external smart card reader devices that
plug into a PC to provide security in the logon process are being replaced by integrated smart card
interface chips that are embedded directly into laptops or keyboards. 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.
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. For example, we are currently
developing a range of new products featuring a secure wireless connectivity known as near field
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communication, which we believe will be important to capture business in the future. 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. 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.
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:
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the extent to which products must support existing industry standards and provide
interoperability; |
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the extent to which standards are widely adopted and product interoperability is
required within industry segments; |
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the extent to which products are differentiated based on technical features, quality
and reliability, ease of use, strength of distribution channels and price; and |
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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 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.
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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.
A significant portion of our PC Security business is dependent upon sales for government programs,
which are impacted by uncertainty of timelines and budgetary allocations, as well as by delays in
developing standards for information technology (IT) projects and in coordinating all aspects of
large smart card-based security programs.
Historically, we have sold a significant proportion of our PC Security products to the
U.S. government and we anticipate that a significant portion of our future revenues will continue
to come from the government sector, both in the U.S. and internationally. In addition, we have
spent significant resources developing eHealth100 smart card terminals for the German governments
electronic healthcard program. The timing of government smart card programs is not always certain
and delays in program implementation are common. For example, budget freezes by the U.S. government
during the second quarter of 2007 contributed to delayed orders for our smart card reader products.
There have also been delays in implementing the German eHealth program. While the U.S. government
has announced plans for several new smart card-based security projects, few have yet reached a
stage of sustained high volume card or reader deployment, in part due to delays in reaching
agreement on specifications for a new federally mandated set of identity credentials. In addition,
government expenditures on IT projects have varied in the past and we expect them to vary in the
future, for example, due to shifting priorities in the U.S. federal budget and in the Department of
Homeland Security. In Germany, the government has stated that it plans to distribute new electronic
health cards to its citizens beginning in late 2008 and to have in place a corresponding network
and card reader infrastructure by 2009; however, the actual timing of equipment and card
deployments in the German eHealth program remain uncertain. The continued delay of government
projects for any reason could negatively impact our sales.
We may have 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. 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.
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 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. |
Each of these factors 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.
Large stock holdings outside the U.S. make it difficult for us to achieve quorum at stockholder
meetings and this could restrict, delay or prevent our ability to implement future corporate
actions, as well as have other effects, such as the delisting of our stock from the NASDAQ Stock
Market.
To achieve a quorum at a regular or special stockholder meeting, at least one-third of all
shares of our stock entitled to vote must be present at such a meeting in person or by proxy. As of
May 2, 2008, the record date for our 2008 Annual Meeting of Stockholders, approximately 50% of our
shares outstanding were held by retail stockholders in Germany, through German banks and brokers.
Securities regulations and business customs in Germany result in very few German banks and brokers
providing our proxy materials to our stockholders in Germany and in very few German stockholders
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voting their shares even when they do receive such materials. In addition, the absence of a
routine broker non-vote in Germany typically requires the stockholder to return the proxy card to
us before the votes it represents can be counted for purposes of establishing a quorum.
As a result, it is often difficult and costly for us, and requires considerable management
resources, to achieve a quorum at annual and special meetings of our stockholders, and we may not
be successful in obtaining proxies from a sufficient number of our stockholders to constitute a
quorum in the future. If we are unable to achieve a quorum at a future annual or special meeting
of our stockholders, corporate actions requiring stockholder approval could be restricted, delayed
or even prevented. These include, but are not limited to, actions and transactions that may be of
benefit to our stockholders, part of our strategic plan or necessary for our corporate governance,
such as corporate mergers, acquisitions, dispositions, sales or reorganizations, financings, stock
incentive plans or the election of directors. Even if we are able to achieve a quorum for a
particular meeting, some of these actions or transactions require the approval of a majority of the
total number of our shares then outstanding, and we may not be successful in obtaining such
approval. The failure to hold an annual meeting of stockholders may result in our being out of
compliance with Delaware law and the qualitative listing requirements of the NASDAQ Stock Market,
each of which requires us to hold an annual meeting of our stockholders. Our inability to obtain a
quorum at any such meeting may not be an adequate excuse for such failure. Lack of compliance with
the qualitative listing requirements of the NASDAQ Stock Market could result in the delisting of
our common stock on the NASDAQ Stock Market. Either of these events would divert managements
attention from our operations and would likely be costly and could also have an adverse effect on
the trading price of our common stock.
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, India, Japan and the United States. We also must manage contract manufacturers
in several different countries, including, for example, Singapore. Managing our various
development, sales, administrative and manufacturing operations places a significant burden on our
financial systems and has resulted in 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 67% of our revenue for the three months
ended March 31, 2008 and approximately 49% of our revenue for the year ended December 31, 2007 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 substantial portion of our revenues. As a result, a significant portion
of our sales and operations
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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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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. |
Fluctuations in the valuation of foreign currencies could impact costs and/or revenues we
disclose in U.S. dollars, and could result in foreign currency losses.
A significant portion of our business is conducted in foreign currencies, principally the
euro. Fluctuations in the value of foreign currencies relative to the U.S. dollar will continue to
cause currency exchange gains and losses. If a significant portion of operating expenses are
incurred in a foreign currency such as the euro, and revenues are generated in U.S. dollars,
exchange rate fluctuations might have a positive or negative net financial impact on these
transactions, depending on whether the U.S. dollar devalues or revalues compared to the euro. For
example, our general and administrative expenses in the first quarter of 2008 were higher than in
the same period of the previous year primarily due to the devaluation of the dollar as compared
with the euro. We cannot predict the effect of exchange rate fluctuations upon future quarterly and
annual operating results. The effect of currency exchange rate changes may increase or decrease our
costs and/or revenues in any given quarter, and we may experience currency losses in the future. To
date, we have not adopted a hedging program to protect us from risks associated with foreign
currency fluctuations.
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. 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.
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.
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.
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 and the level of competition we face for that
customers business. Any delays in the sales cycle for new customers could delay or reduce our
receipt of new revenue and could cause us to
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expend more resources to obtain new customer wins. If we are unsuccessful in managing sales
cycles, our business could be adversely affected.
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. Any future acquisition could expose us to significant risks,
including, without limitation, the use of our limited cash balances or potentially dilutive stock
offerings to fund such acquisitions; costs of any necessary financing, which may not be available
on reasonable terms or at all; accounting charges we might incur in connection with such
acquisitions; the difficulty and expense of integrating personnel, technologies, customer, supplier
and distributor relationships, marketing efforts and facilities acquired through acquisitions;
integrating internal controls over financial reporting; discovering and correcting deficiencies in
internal controls and other regulatory compliance, data adequacy and integrity, product quality and
product liabilities; diversion of our management resources; failure to realize anticipated
benefits; costly fees for legal and transaction-related services; and the unanticipated assumption
of liabilities. Any of the foregoing could have a material adverse effect on our financial
condition and results of operations. We may not be successful with any such acquisition.
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 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 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.
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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 during and after 2007. The process of maintaining and evaluating the
effectiveness of these controls is expensive, time-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.
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.
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
38
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.
We are exposed to credit risk on our accounts receivable. This risk is heightened in times of
economic weakness.
We distribute our products both through third-party resellers and directly to certain
customers. A substantial 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. Additionally, if the global economy and regional economies deteriorate, one or
more of our customers could experience a weakened financial condition and we could incur a material
loss or losses as a result.
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.
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.
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.
From time to time, in the future we may issue 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 40,000,000 shares of common stock. As of May 5, 2008, 15,743,515 shares
of common stock were outstanding.
In 2007, our Board of Directors and our stockholders approved our 2007 Stock Option Plan,
under which options to purchase 1.5 million shares of our common stock may be granted. As of March
31, 2008, an aggregate of approximately 3.1 million shares of common stock was reserved for future
issuance under our stock option plans, of which 1.8 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 our 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 our 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.
39
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None
Item 3. Defaults upon Senior Securities.
None
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information.
None
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.
40
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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May 14, 2008 |
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/s/ Felix Marx
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Felix Marx |
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Chief Executive Officer |
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May 14, 2008 |
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/s/ Stephan Rohaly
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Stephan Rohaly |
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Chief Financial Officer and Secretary |
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41
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. |
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3.2(2)
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Amended and Restated Bylaws of Registrant. |
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3.3(3)
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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(1)
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Form of Registrants Common Stock Certificate. |
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4.2(3)
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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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10.31(4)*
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Employment Agreement between Sour Chhor and SCM GmbH dated January 21, 2008. |
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10.32(4)*
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Side Letter to the Employment Agreement between Sour Chhor and SCM GmbH
dated January 23, 2008. |
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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-1 (See SEC File No. 333-29073). |
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(2) |
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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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(3) |
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Filed previously as an exhibit to SCMs Registration Statement on Form 8-A (See SEC File No. 000-29440). |
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(4) |
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Filed previously as an exhibit to SCMs Current Report on Form 8-K, dated January 24, 2008 (see SEC
File No. 000-29440). |
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* |
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Denotes management compensatory arrangement. |
42