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 SEPTEMBER 30, 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
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(I.R.S. EMPLOYER |
INCORPORATION OR ORGANIZATION)
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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 o
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Accelerated filer o
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Non-accelerated filer o
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Smaller reporting company þ |
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(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
At November 3, 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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Nine Months Ended |
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September 30, |
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September 30, |
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2008 |
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2007 |
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2008 |
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2007 |
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Net revenue |
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$ |
6,393 |
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$ |
7,617 |
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$ |
19,377 |
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$ |
20,721 |
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Cost of revenue |
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3,483 |
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4,170 |
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10,961 |
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12,201 |
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Gross profit |
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2,910 |
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3,447 |
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8,416 |
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8,520 |
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Operating expenses: |
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Research and development |
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980 |
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815 |
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3,058 |
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2,327 |
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Selling and marketing |
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2,280 |
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1,625 |
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7,010 |
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4,802 |
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General and administrative |
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1,697 |
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1,374 |
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4,718 |
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5,653 |
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Amortization of intangible assets |
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272 |
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Restructuring and other charges |
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(4 |
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(4 |
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Total operating expenses |
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4,957 |
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3,810 |
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14,786 |
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13,050 |
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Loss from operations |
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(2,047 |
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(363 |
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(6,370 |
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(4,530 |
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Interest and other income (expenses), net |
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(1,117 |
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279 |
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(293 |
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999 |
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Loss from continuing operations before income taxes |
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(3,164 |
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(84 |
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(6,663 |
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(3,531 |
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Provision for income taxes |
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(103 |
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(32 |
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(151 |
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(124 |
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Loss from continuing operations |
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(3,267 |
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(116 |
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(6,814 |
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(3,655 |
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Income (loss) from discontinued operations, net of income taxes |
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424 |
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(83 |
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273 |
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(202 |
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Gain on sale of discontinued operations, net of income taxes |
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44 |
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16 |
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553 |
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1,569 |
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Net loss |
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$ |
(2,799 |
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$ |
(183 |
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$ |
(5,988 |
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$ |
(2,288 |
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Loss per share from continuing operations: |
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Basic and diluted |
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$ |
(0.21 |
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$ |
(0.01 |
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$ |
(0.43 |
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$ |
(0.23 |
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Gain (loss) per share from discontinued operations: |
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Basic and diluted |
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$ |
0.03 |
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$ |
(0.00 |
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$ |
0.05 |
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$ |
0.08 |
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Net loss per share: |
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Basic and diluted |
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$ |
(0.18 |
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$ |
(0.01 |
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$ |
(0.38 |
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$ |
(0.15 |
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Shares used to compute basic and diluted loss per share |
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15,744 |
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15,736 |
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15,743 |
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15,722 |
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Comprehensive gain (loss): |
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Net loss |
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$ |
(2,799 |
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$ |
(183 |
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$ |
(5,988 |
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$ |
(2,288 |
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Unrealized gain (loss) on investments |
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1 |
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28 |
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11 |
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Foreign currency translation adjustment |
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(24 |
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450 |
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(203 |
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984 |
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Total comprehensive gain (loss) |
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$ |
(2,823 |
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$ |
268 |
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$ |
(6,163 |
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$ |
(1,293 |
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See notes to condensed consolidated financial statements.
3
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
(unaudited)
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September 30, |
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December 31, |
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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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$ |
25,020 |
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$ |
18,600 |
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Short-term investments |
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0 |
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13,844 |
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Accounts receivable, net of allowances of $495 and $341 as of September 30, 2008 and December 31, 2007, respectively |
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6,368 |
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8,638 |
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Inventories |
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4,321 |
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2,738 |
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Other current assets |
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1,310 |
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1,455 |
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Total current assets |
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37,019 |
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45,275 |
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Property and equipment, net |
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1,313 |
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1,522 |
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Intangible assets, net |
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321 |
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Other assets |
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1,947 |
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1,767 |
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Total assets |
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$ |
40,600 |
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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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$ |
2,484 |
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$ |
3,063 |
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Accrued compensation and related benefits |
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1,244 |
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1,213 |
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Accrued restructuring and other charges |
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1,715 |
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2,960 |
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Accrued professional fees |
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896 |
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993 |
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Accrued royalties |
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385 |
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417 |
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Other accrued expenses |
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2,278 |
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2,325 |
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Income taxes payable |
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245 |
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277 |
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Total current liabilities |
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9,247 |
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11,248 |
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Deferred tax liability |
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74 |
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77 |
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Long-term income taxes payable |
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142 |
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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, $0.001 par value: 40,000 shares authorized; 16,362 and 16,356 shares issued and 15,744 and 15,737
shares outstanding as of September 30, 2008 and December 31, 2007, respectively |
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16 |
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16 |
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Additional paid-in capital |
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229,675 |
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229,414 |
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Treasury stock, 618 shares |
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(2,777 |
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(2,777 |
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Accumulated deficit |
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(198,077 |
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(192,089 |
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Accumulated other comprehensive income |
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2,300 |
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2,475 |
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Total stockholders equity |
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31,137 |
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37,039 |
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Total liabilities and stockholders equity |
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$ |
40,600 |
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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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Nine Months |
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Ended September 30, |
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2008 |
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2007 |
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Cash flows from operating activities: |
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Net loss |
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$ |
(5,988 |
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$ |
(2,288 |
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Adjustments to reconcile net loss to net cash provided by (used in)
operating activities: |
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Gain from discontinued operations |
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(826 |
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(1,367 |
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Depreciation and amortization |
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216 |
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500 |
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Loss (gain) on disposal of fixed assets |
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(6 |
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Stock compensation expense |
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242 |
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639 |
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Deferred income taxes |
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(2 |
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(2 |
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Changes in operating assets and liabilities: |
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Accounts receivable |
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2,004 |
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542 |
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Inventories |
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(1,704 |
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(893 |
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Other assets |
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(352 |
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1,246 |
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Accounts payable |
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(381 |
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(2,143 |
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Accrued expenses |
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283 |
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(1,619 |
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Income taxes payable |
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(47 |
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98 |
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Net cash used in operating activities from continuing operations |
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(6,555 |
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(5,293 |
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Net cash provided by (used in) operating activities from discontinued operations |
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(350 |
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697 |
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Net cash used in operating activities |
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(6,905 |
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(4,596 |
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Cash flows from investing activities: |
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Capital expenditures |
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(534 |
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(178 |
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Maturities of short-term investments |
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13,873 |
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12,656 |
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Purchases of short-term investments |
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(16,793 |
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Net cash provided by (used in) investing activities |
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13,339 |
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(4,315 |
) |
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Cash flows from financing activities: |
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Proceeds from issuance of equity securities, net |
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18 |
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104 |
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Net cash provided by financing activities |
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18 |
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104 |
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Effect of exchange rates on cash and cash equivalents |
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(32 |
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847 |
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Net increase (decrease) in cash and cash equivalents |
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6,420 |
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(7,960 |
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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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$ |
25,020 |
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$ |
24,143 |
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Supplemental disclosures of cash flow information: |
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Income tax refunds received |
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$ |
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$ |
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Income taxes paid |
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$ |
175 |
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$ |
108 |
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See notes to condensed consolidated financial statements.
5
SCM MICROSYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 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 SCM Microsystems, Inc.s (SCM or
the Company) financial position, results of operations and cash flows have been included.
Operating results for the three and nine months ended September 30, 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
the Companys Annual Report on Form 10-K for the year ended December 31, 2007. The preparation of
unaudited condensed consolidated financial statements necessarily requires the Company to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the condensed consolidated balance sheet dates and the
reported amounts of revenues and expenses for the periods presented.
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 $9.0
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 and nine months ended September
30, 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 is capitalized as an intangible asset and amortized over its
estimated useful life. The adoption of SFAS No. 141(R) will change the Companys 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
September 30, 2008, SCM did not have any minority interests.
On January 1, 2008, the Company 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 SCMs consolidated financial position, results of operations or cash
flows.
6
On January 1, 2008, SCM 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 (i.e., 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 the Companys 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.
SFAS No. 157 establishes a fair value hierarchy that requires an entity to maximize the use of
observable objective inputs and minimize the use of unobservable inputs, which require additional
reliance on the Companys judgment, when measuring fair value. A financial instruments
categorization within the fair value hierarchy is based upon the lowest level of input that is
significant to the fair value measurement. 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,
commercial paper and treasury bills) with maturities of three months or less at the date of
acquisition. These financial instruments are classified in Level 1 of the fair value hierarchy.
Short-term investments consist of corporate notes and United States government agency
instruments and are classified as available-for-sale. These financial instruments are classified in
Level 1 of the fair value hierarchy. As of September 30, 2008, the Company has no short-term
investments.
Assets that are measured and recognized at fair value on a recurring basis classified under
the appropriate level of the fair value hierarchy as of September 30, 2008 were as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
|
Total |
|
Money market fund deposits |
|
$ |
11,455 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
11,455 |
|
Treasury Bills |
|
|
4,000 |
|
|
|
|
|
|
|
|
|
|
|
4,000 |
|
Commercial papers |
|
|
1,992 |
|
|
|
|
|
|
|
|
|
|
|
1,992 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total: |
|
$ |
17,447 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
17,447 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2008, there are no liabilities that are measured and recognized at fair
value on a recurring basis.
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, 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 (i.e., at least annually),
until the beginning of the first quarter of fiscal 2009. The Company is currently evaluating the
impact that SFAS No. 157 will have on its 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.
7
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 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
enrollment or the date of purchase. Shares issued as a result of stock option exercises and
purchases under the Companys ESPP were newly issued shares. The Companys ESPP, Director Option
Plan and 1997 Stock Option Plan all expired in March 2007. In November 2007, stockholders approved
the 2007 Stock Option Plan, which authorizes the issuance of up to 1.5 million shares of the
Companys common stock pursuant to stock option grants.
As of September 30, 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 1.9
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 and nine months ended September 30, 2008 and 2007 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Cost of revenue |
|
$ |
6 |
|
|
$ |
18 |
|
|
$ |
16 |
|
|
$ |
51 |
|
Research and development |
|
|
12 |
|
|
|
21 |
|
|
|
36 |
|
|
|
65 |
|
Selling and marketing |
|
|
30 |
|
|
|
77 |
|
|
|
92 |
|
|
|
177 |
|
General and administrative |
|
|
70 |
|
|
|
117 |
|
|
|
98 |
|
|
|
346 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based
compensation expense
before income taxes |
|
$ |
118 |
|
|
$ |
233 |
|
|
$ |
242 |
|
|
$ |
639 |
|
Income tax benefit |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based
compensation expense
after income taxes |
|
$ |
118 |
|
|
$ |
233 |
|
|
$ |
242 |
|
|
$ |
639 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Option Plans
The Companys Director Option Plan and 1997 Stock Option Plan expired in March 2007, and
options can no longer be granted under these plans. However, outstanding options granted under
these plans remain exercisable in accordance with the terms of the original grant agreements.
In November 2007, stockholders approved the 2007 Stock Option Plan, which authorizes the
issuance of up to 1.5 million shares of the Companys common stock pursuant to stock option grants.
As of September 30, 2008, a total of 1.1 million shares of the Companys common stock are reserved
for future option grants under the 2000 Stock Option Plan and the 2007 Stock Option Plan, and 1.9
million shares were reserved for future issuance pursuant to outstanding options.
8
A summary of the activity under the Companys stock option plans for the nine months ended
September 30, 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 |
|
|
(536,171 |
) |
|
|
536,171 |
|
|
$ |
3.11 |
|
|
|
|
|
|
|
|
|
Options cancelled or expired |
|
|
187,061 |
|
|
|
(448,023 |
) |
|
$ |
15.92 |
|
|
|
|
|
|
|
|
|
Options exercised |
|
|
|
|
|
|
(6,250 |
) |
|
$ |
2.93 |
|
|
$ |
1,507 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at September 30, 2008 |
|
|
1,144,383 |
|
|
|
1,944,170 |
|
|
$ |
7.69 |
|
|
$ |
0 |
|
|
|
5.72 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested or expected to vest
at September 30, 2008 |
|
|
|
|
|
|
1,772,001 |
|
|
$ |
8.12 |
|
|
$ |
0 |
|
|
|
5.59 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exerciseable at September 30, 2008 |
|
|
|
|
|
|
1,094,584 |
|
|
$ |
11.13 |
|
|
$ |
0 |
|
|
|
4.69 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The weighted-average grant date fair value per option for options granted during the three and
nine months ended September 30, 2008 was $1.38 and $1.39, respectively. The weighted-average grant
date fair value per option for options granted during the three and nine months ended September 30,
2007 was $1.38 and $1.90, respectively. The total intrinsic value of options exercised during the
three and nine months ended September 30, 2008 was zero and $1,500, respectively. The total
intrinsic value of options exercised during the three and nine months ended September 30, 2007 was
zero and $8,331, respectively. Cash proceeds from the exercise of stock options were zero and
$18,000 for the three and nine months ended September 30, 2008, respectively. Cash proceeds from
the exercise of stock options were zero and $33,135 for the three and nine months ended September
30, 2007, respectively. An income tax benefit of less than $1,000 was realized from stock option
exercises during both the three and nine months ended September 30, 2008. No income tax benefit was
realized from stock option exercises during both the three and nine months ended September 30,
2007. At September 30, 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 2.7 years.
The fair value of option grants was estimated by using the Black-Scholes-Merton model with the
following weighted-average assumptions for the three and nine months ended September 30, 2008 and
2007, respectively:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Expected volatility |
|
|
57 |
% |
|
|
54 |
% |
|
|
55 |
% |
|
|
57 |
% |
Dividend yield |
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
|
|
0 |
|
Risk-free interest rate |
|
|
2.87 |
% |
|
|
4.13 |
% |
|
|
2.72 |
% |
|
|
4.53 |
% |
Expected term (in years) |
|
|
4.00 |
|
|
|
4.00 |
|
|
|
4.00 |
|
|
|
4.00 |
|
Expected Volatility: The Companys computation of expected volatility for both the three and
nine months ended September 30, 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.
9
Expected Term: The Companys expected term represents the period that the Companys
stock-based awards are expected to be outstanding and was determined for both the three and nine
months ended September 30, 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.
Forfeitures Rate: Compensation expense recognized in the consolidated statement of operations
for both the three and nine months ended September 30, 2008 and 2007 is based on awards ultimately
expected to vest and it reflects estimated forfeitures. FASB SFAS No. 123 revised 2004 (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. Prior to adoption of SFAS
123(R), the Company accounted for forfeitures as they occurred.
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 of 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 September 30, 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 both the three and nine months ended September 30, 2008 was zero. Stock-based compensation
expense related to the Companys ESPP recognized under SFAS 123(R) for the three and nine months
ended September 30, 2007 was zero and a benefit of $40,000, respectively. The benefit in the first
nine months of 2007 stemmed from the expiration of the plan before the expected offering periods
had terminated. At September 30, 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 $9.0 million was paid at the time of sale and $1.6 million, which
was paid in May 2007.
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived
Assets, for both the three and nine months ended September 30, 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 and nine months ended September 30, 2008 and 2007 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Net revenue |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
496 |
|
Operating gain (loss) |
|
$ |
32 |
|
|
$ |
45 |
|
|
$ |
26 |
|
|
$ |
33 |
|
Net income (loss) before income taxes |
|
$ |
32 |
|
|
$ |
45 |
|
|
$ |
26 |
|
|
$ |
56 |
|
Income tax benefit (provision) |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
(16 |
) |
Income (loss) from discontinued
operations |
|
$ |
32 |
|
|
$ |
45 |
|
|
$ |
26 |
|
|
$ |
40 |
|
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.
In April 2008, the Company entered into an agreement to terminate its lease agreement for
premises leased in the UK, which resulted in the gain on sale of discontinued operations of
approximately $0.4 million in the second quarter of 2008.
The operating results for the discontinued operations of the retail Digital Media and Video
business for the three and nine months ended September 30, 2008 and 2007 are as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Net revenue |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Operating loss |
|
$ |
(58 |
) |
|
$ |
(82 |
) |
|
$ |
(202 |
) |
|
$ |
(236 |
) |
Net gain (loss) before income taxes |
|
$ |
365 |
|
|
$ |
(72 |
) |
|
$ |
225 |
|
|
$ |
(186 |
) |
Income tax provision |
|
$ |
27 |
|
|
$ |
(56 |
) |
|
$ |
22 |
|
|
$ |
(56 |
) |
Gain (loss) from discontinued
operations |
|
$ |
392 |
|
|
$ |
(128 |
) |
|
$ |
247 |
|
|
$ |
(242 |
) |
The net gain from discontinued operations for the three and nine months ended September 30,
2008 mainly resulted from foreign exchange gains in the third quarter of 2008.
11
4. Short-Term Investments
At September 30, 2008, the amount of short-term investments was zero. The fair value of
short-term investments at December 31, 2007 was as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 during the quarter ended March 31, 2008, see Note 1 Basis
of Presentation for further discussion and explanation.
5. Inventories
Inventories consist of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
Raw materials |
|
$ |
1,586 |
|
|
$ |
1,202 |
|
Finished goods |
|
|
2,735 |
|
|
|
1,536 |
|
|
|
|
|
|
|
|
Total |
|
$ |
4,321 |
|
|
$ |
2,738 |
|
|
|
|
|
|
|
|
6. Property and Equipment
Property and equipment consists of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
Land |
|
$ |
121 |
|
|
$ |
142 |
|
Building and
leasehold improvements |
|
|
1,746 |
|
|
|
1,972 |
|
Furniture, fixtures and office equipment |
|
|
2,904 |
|
|
|
3,223 |
|
Automobiles |
|
|
29 |
|
|
|
35 |
|
Purchased software |
|
|
3,282 |
|
|
|
3,526 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
8,082 |
|
|
|
8,898 |
|
|
|
|
|
|
|
|
Accumulated depreciation |
|
|
(6,769 |
) |
|
|
(7,376 |
) |
|
|
|
|
|
|
|
Property and equipment, net |
|
$ |
1,313 |
|
|
$ |
1,522 |
|
|
|
|
|
|
|
|
Depreciation expense was $0.1 million and $0.2 million for the three and nine months ended
September 30, 2008, respectively, and $0.1 million and $0.2 million for the three and nine months
ended September 30, 2007, respectively.
12
7. Intangible Assets
Amortization expense related to intangible assets for continuing operations was zero for the
three and nine months ended September 30, 2008, and zero and $0.3 million for the three and nine
months ended September 30, 2007, respectively.
As described in
Note 13 to the financial statements, the Companys investment in
TranZfinity, Inc. (TranZfinity)
follows an exclusive Cooperation Agreement entered into on April 17, 2008 with TranZfinity and on
October 1, 2008, the Company and TranZfinity entered into an amendment to the Cooperation
Agreement. Under the terms of the Cooperation Agreement, as amended, TranZfinity will work with the
Company to develop modular USB devices for the Companys product portfolio and will supply the
Companys customers with TranZfinitys application software and services supporting those devices,
and the Company will pay TranZfinity a $1.0 million exclusivity fee for the right to be the
exclusive provider of those products (the Exclusive Products). The exclusivity fee is comprised
of $500,000 cash (of which the remaining balance to be paid was $179,298 as of September 30, 2008),
and a $4 payment from the Company to TranZfinity for each Exclusive Product sold by the Company (up
to a maximum aggregate amount of $500,000, of which the remaining balance is the full $500,000 as
of September 30, 2008). The $320,702 already paid in relation to the exclusivity fee has been
capitalized in September 2008 as an intangible asset, which will be subject to amortization
starting in the fourth quarter 2008.
8. Restructuring and Other Charges
Continuing Operations
During the three and nine months ended September 30, 2008, the Company incurred no
restructuring and other charges related to continuing operations. During the three and nine months
ended September 30, 2007, the Company realized income from the release of a severance accrual
related to continuing operations of $4,000.
Accrued liabilities related to restructuring actions and other activities during the nine
months ended September 30, 2008 and during the year ended December 31, 2007 consist of the
following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease/Contract |
|
|
|
|
|
|
Other |
|
|
|
|
|
|
Commitments |
|
|
Severance |
|
|
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for Q2 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments and other changes in Q2 2008 |
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
(1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances as of June 30, 2008 |
|
|
11 |
|
|
|
|
|
|
|
10 |
|
|
|
21 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for Q3 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments and other changes in Q3 2008 |
|
|
(2 |
) |
|
|
|
|
|
|
(1 |
) |
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances as of September 30, 2008 |
|
$ |
9 |
|
|
$ |
|
|
|
$ |
9 |
|
|
$ |
18 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13
Discontinued Operations
During the three and nine months ended September 30, 2008, income from restructuring and other
items related to discontinued operations was approximately $46,000 and 0.6 million, respectively.
In the second quarter 2008, a termination payment and related transaction costs of approximately
$0.5 million were incurred and the related restructuring accruals of approximately $0.9 million
were released related primarily to an agreement to terminate our lease agreement for the premises
leased in the UK. The transaction resulted in a net gain of approximately $0.4 million from
discontinued operations in the second quarter 2008.
During the three and nine months ended September 30, 2007, income from restructuring and other
items related to discontinued operations was approximately $16,000 and $92,000, respectively.
Accrued liabilities related to the Digital Media and Video restructuring actions and other
activities during the nine months ended September 30, 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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for Q2 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
(494 |
) |
|
|
|
|
|
|
(494 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(494 |
) |
|
|
|
|
|
|
(494 |
) |
Payments and other changes in Q2 2008 |
|
|
(539 |
) |
|
|
(2 |
) |
|
|
(541 |
) |
|
|
|
|
|
|
|
|
|
|
Balances as of June 30, 2008 |
|
|
1,483 |
|
|
|
373 |
|
|
|
1,856 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for Q3 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
Changes in estimates |
|
|
(46 |
) |
|
|
|
|
|
|
(46 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(46 |
) |
|
|
|
|
|
|
(46 |
) |
Payments and other changes in Q3 2008 |
|
|
(74 |
) |
|
|
(39 |
) |
|
|
(113 |
) |
|
|
|
|
|
|
|
|
|
|
Balances as of September 30, 2008 |
|
$ |
1,363 |
|
|
$ |
334 |
|
|
$ |
1,697 |
|
|
|
|
|
|
|
|
|
|
|
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.
14
The Companys continuing operations provide secure digital access solutions primarily to
original equipment manufacturers, or OEMs, 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 and nine months ended September 30, 2008 and 2007
is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
PC Security: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue |
|
$ |
5,873 |
|
|
$ |
6,140 |
|
|
$ |
15,758 |
|
|
$ |
17,100 |
|
Gross profit |
|
|
2,748 |
|
|
|
2,846 |
|
|
|
7,172 |
|
|
|
7,345 |
|
Gross profit % |
|
|
47 |
% |
|
|
46 |
% |
|
|
46 |
% |
|
|
43 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Digital Media Readers: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue |
|
$ |
520 |
|
|
$ |
1,477 |
|
|
$ |
3,619 |
|
|
$ |
3,621 |
|
Gross profit |
|
|
162 |
|
|
|
601 |
|
|
|
1,244 |
|
|
|
1,175 |
|
Gross profit % |
|
|
31 |
% |
|
|
41 |
% |
|
|
34 |
% |
|
|
32 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue |
|
$ |
6,393 |
|
|
$ |
7,617 |
|
|
$ |
19,377 |
|
|
$ |
20,721 |
|
Gross profit |
|
|
2,910 |
|
|
|
3,447 |
|
|
|
8,416 |
|
|
|
8,520 |
|
Gross profit % |
|
|
46 |
% |
|
|
45 |
% |
|
|
43 |
% |
|
|
41 |
% |
Geographic net revenue is based on selling location. Information regarding net revenue by
geographic region is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Net revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
$ |
2,655 |
|
|
$ |
3,635 |
|
|
$ |
7,214 |
|
|
$ |
9,574 |
|
Europe |
|
|
2,064 |
|
|
|
2,603 |
|
|
|
7,151 |
|
|
|
6,716 |
|
Asia-Pacific |
|
|
1,674 |
|
|
|
1,379 |
|
|
|
5,012 |
|
|
|
4,431 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
6,393 |
|
|
$ |
7,617 |
|
|
$ |
19,377 |
|
|
$ |
20,721 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
% of net revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States |
|
|
42 |
% |
|
|
48 |
% |
|
|
37 |
% |
|
|
47 |
% |
Europe |
|
|
32 |
% |
|
|
34 |
% |
|
|
37 |
% |
|
|
32 |
% |
Asia-Pacific |
|
|
26 |
% |
|
|
18 |
% |
|
|
26 |
% |
|
|
21 |
% |
15
Long-lived assets by geographic location as of September 30, 2008 and December 31, 2007, are
as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
December 31, |
|
|
|
2008 |
|
|
2007 |
|
Property and equipment, net: |
|
|
|
|
|
|
|
|
United States |
|
$ |
7 |
|
|
$ |
14 |
|
Europe |
|
|
201 |
|
|
|
171 |
|
Asia-Pacific |
|
|
1,105 |
|
|
|
1,337 |
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,313 |
|
|
$ |
1,522 |
|
|
|
|
|
|
|
|
All
of the long-lived assets as of September 30, 2008, and December 31, 2007, disclosed for
Asia-Pacific, relate to the Companys facilities in India.
10. Commitments
The Company leases its facilities, certain equipment, and automobiles under noncancelable
operating lease agreements. Those lease agreements existing as of
September 30, 2008, expire at
various dates during the next five years.
Purchases for inventories are highly dependent upon forecasts of customer demand. Due to the
uncertainty in demand from its customers, the Company may have to change, reschedule, or cancel
purchases or purchase orders from its suppliers. These changes may lead to vendor cancellation
charges on these purchases or contractual commitments. The Company enters into a number of
agreements for the sourcing of supplies and materials including some arrangements with minimum
purchase commitments. As of September 30, 2008, total purchase and contractual commitments due
within one year were approximately $10.1 million, and additional purchase and contractual
commitments due within two years were approximately $2.6 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.
Components of the reserve for warranty costs for the nine months ended September 30, 2008 and
2007 were as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
|
2007 |
|
Balances at January 1 |
|
$ |
36 |
|
|
$ |
34 |
|
Additions related to sales during the period |
|
|
32 |
|
|
|
46 |
|
Warranty costs incurred during the period |
|
|
(19 |
) |
|
|
(49 |
) |
Adjustments to accruals related to prior period sales |
|
|
(28 |
) |
|
|
(2 |
) |
|
|
|
|
|
|
|
Balances at September 30 |
|
$ |
21 |
|
|
$ |
29 |
|
|
|
|
|
|
|
|
16
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 |
|
|
For the Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Net loss from continuing operations |
|
$ |
(3,267 |
) |
|
$ |
(116 |
) |
|
$ |
(6,814 |
) |
|
$ |
(3,655 |
) |
Income (loss) from discontinued operations |
|
|
468 |
|
|
|
(67 |
) |
|
|
826 |
|
|
|
1,367 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
|
$ |
(2,799 |
) |
|
$ |
(183 |
) |
|
$ |
(5,988 |
) |
|
$ |
(2,288 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in income (loss) per common
share basic |
|
|
15,744 |
|
|
|
15,736 |
|
|
|
15,743 |
|
|
|
15,722 |
|
Net income (loss) per common share basic
and diluted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Continuing operations |
|
$ |
(0.21 |
) |
|
$ |
(0.01 |
) |
|
$ |
(0.43 |
) |
|
$ |
(0.23 |
) |
Discontinued operations |
|
$ |
0.03 |
|
|
$ |
(0.00 |
) |
|
$ |
0.05 |
|
|
$ |
0.08 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss per common share basic and diluted |
|
$ |
(0.18 |
) |
|
$ |
(0.01 |
) |
|
$ |
(0.38 |
) |
|
$ |
(0.15 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
The computation of diluted net loss per common share for the three and nine months ended
September 30, 2008 excludes the effect of the potential exercise of options to purchase
approximately zero and 3,000 shares, respectively, because the effect would be anti-dilutive in
periods when there is a net loss. The computation of diluted net loss per common share for the
three and nine months ended September 30, 2008 also excludes the effect of the potential exercise
of options to purchase approximately 2.0 million and 1.9 million shares, respectively, because the
option exercise price was greater than the average market price of the common shares and the effect
would have been anti-dilutive.
The computation of diluted net income (loss) per common share for the three and nine months
ended September 30, 2007 excludes the effect of the potential exercise of options to purchase
approximately 7,000 and 33,000 shares, respectively, because the effect would be anti-dilutive in
periods when there is a net loss. The computation of diluted net income (loss) per common share for
the three and nine months ended September 30, 2007 also excludes the effect of the potential
exercise of options to purchase approximately 1.7 million and 1.7 million shares, respectively,
because the option exercise price was greater than the average market price of the common shares
and the effect would have been anti-dilutive.
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
Investment in TranZfinity
On
October 1, 2008, the Company entered into a Stock Purchase
Agreement with TranZfinity,
pursuant to which the Company purchased 10 million shares of TranZfinity common
stock, or 33.7% of TranZfinitys outstanding shares (16.67% on a fully diluted basis), for an
aggregate purchase price of $2.5 million. The transaction closed on October 2, 2008. The Company
also entered into a Stockholders Agreement with TranZfinity and certain other stockholders of
TranZfinity, which sets forth certain rights and privileges of the Company and the other
stockholders of TranZfinity, including rights and privileges with respect to the composition of
TranZfinitys Board of Directors.
The Companys investment in TranZfinity follows an exclusive Cooperation Agreement entered
into on April 17, 2008 with TranZfinity. On October 1, 2008, the Company and TranZfinity entered
into an amendment to the Cooperation Agreement pursuant to which TranZfinity consented to the
assignment by SCM Microsystems GmbH and the assumption by
17
SCM Microsystems, Inc. of all of SCM
Microsystems GmbHs rights and obligations under the Cooperation Agreement. Under the terms of the
Cooperation Agreement, as amended, TranZfinity will work with the Company to develop modular USB
devices for the Companys product portfolio and will supply the Companys customers with
TranZfinitys application software and services supporting those devices, and the Company will pay
TranZfinity a $1.0 million exclusivity fee for the right to be the exclusive provider of those
products (the Exclusive Products). The exclusivity fee is comprised of $500,000 cash (of which
the remaining balance to be paid was $179,298 as of September 30, 2008), and a $4 payment from the
Company to TranZfinity for each Exclusive Product sold by the Company (up to a maximum aggregate
amount of $500,000, of which the remaining balance is the full $500,000 as of September 30, 2008).
In addition to the exclusivity fee, the Company will pay TranZfinity a five percent (5%) royalty on
the Companys net selling price for each Exclusive Product sold by the Company.
Sale of Patents
On October 30, 2008, the Company sold at auction certain non-core patents that are unrelated
to the Companys current business. The Company will receive net proceeds of $1.4 million from the
sale of these patents.
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,
forward-looking statements can be identified 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.
|
18
|
|
|
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 PC Security 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 typically sell our smart card readers to government
contractors, systems integrators, large enterprises and computer manufacturers, as well as banks
and other financial institutions. We sell our digital media readers primarily to computer and photo
processing equipment manufacturers. 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 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.)
Growth Strategies
We have put in place a number of strategies to grow revenues over the long-term, as discussed
below.
Throughout most of 2007, our revenue growth strategy was primarily based on investing in 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 business productivity solutions for small and medium-sized businesses 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.
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.
As part of this strategy, we added sales resources in Europe, Asia and the Americas to increase our
ability to address current and future business opportunities. For example, we added sales resources
to target authentication programs in the government and enterprise sectors in Latin America and
Asia and we began targeting the photo kiosk markets in Europe and Asia. As sales cycles for
government projects and design cycles for photo kiosks may take several quarters, we believe we
will begin to realize revenue from these investments in the first half of 2009.
In early 2008, we implemented an additional growth strategy aimed at further diversifying and
expanding our customer base by targeting the emerging contactless reader market. We have begun
investing to develop new PC Security products based on contactless technologies such as Near Field
Communication and FeliCa® and have initiated business development activities aimed at penetrating
the worldwide financial services and enterprise markets with our contactless reader products. For
example, in October 2008, we introduced the first in a family of new products called @MAXX that
are aimed at the market for contactless applications.
To better leverage our own capabilities, we have also adopted a more active approach to
partnering with other companies that can provide complementary resources and strengths. For
example, in recent months we have worked together with XIRING, a French security solutions company,
to develop a mobile eHealth terminal for the German electronic health card system. We have also
taken an equity position in TranZfinity, a company with which we developed our @MAXX family of
contactless readers and which has agreed to provide application services for those readers.
Additionally, we have signed a distribution agreement with Hirsch Electronics, a supplier of
physical access control systems, to sell our physical access control terminals into their customer
base in the U.S. government.
To ensure that we have the expertise and executive leadership to manage the Company, we have
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. In the first nine months of 2008, we have also added expertise in
contactless technologies and the contactless market with the addition of new sales, marketing and
engineering professionals from the contactless industry. We believe our new executives and the
expanded expertise of our management team strengthen our ability to anticipate and respond to
market trends both in the traditional smart card industry and in the emerging market for
contactless solutions.
19
We have invested in new products, resources and programs to support the growth strategies
described above and this has resulted in increased operating expenses year over year. We believe
these investments are critical to the success of our growth strategies and we expect to continue to
invest in these strategies in the future.
Trends in our Business
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, a significant
proportion 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.
Historically, we have sold a significant proportion of our PC Security products to the U.S.
government for PC and network access by military and federal employees, and these sales have been
an important component of our overall revenue. However, during the first six months of 2008, we
experienced significantly weaker demand for our smart card readers from the U.S. government sector
due to project and budget delays. Sales to the U.S. government market increased in the third
quarter of 2008, returning to levels similar to those we experienced in 2007, as some projects
moved forward. During the past several quarters, we have also experienced an ongoing shift in the
U.S. government market away from external reader devices and towards interface chips that provide
embedded reader technology in laptops and keyboards. We have also sold high volumes of smart card
interface chips for embedded readers to laptop and keyboard manufacturers in Asia that have
partially offset the decrease in sales of our external readers; however these chips have a lower
average selling price than our external reader devices. Our sales to
Asia increased 21% in the third quarter of 2008 and 17% in the first
nine months of 2008 compared with the prior year. We continue to believe that we remain a
leading supplier of smart card reader technology to the U.S. government market and that we are not
losing share to competitors. However, the shift in demand from external reader devices towards
embedded readers in the U.S. government market has resulted and is likely to continue to result in
reduced revenue opportunity for us.
In
the third quarter of 2008, European sales decreased approximately 20%
compared with the prior year quarter due to variability in the timing of orders for regional programs requiring smart card readers.
We continue to expect that the rollout of the new electronic health card in Germany will provide
significant additional opportunity for SCM. Currently we are one of a limited number of suppliers
certified to provide eHealth card terminals approved for this program. However, the timing of the
programs launch is still uncertain, and it may not begin before the end of 2008.
Sales of our Digital Media Reader products are less subject to 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.
During the third quarter of 2008, digital media reader sales were well below recent quarterly
levels due to unexpectedly light orders from a major customer.
Both our PC Security and Digital Media Reader businesses are subject to ongoing pricing
pressure. To counter this trend, we have implemented ongoing cost reduction programs that have
resulted in ongoing improvements to our product margins. We believe we should be able to offset
pricing pressure and material cost increases with ongoing improvements in our supply chain systems.
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.
20
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
September 30, 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. |
|
|
|
|
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 |
21
|
|
|
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. |
|
|
|
|
With the Stock Purchase Agreement with TranZfinity (see Note 13 to Condensed
Consolidated Financial Statements) we have entered into a non-marketable equity
investment. Non-marketable equity investments are inherently risky, and a number of these
companies are likely to fail. Their success is dependent on product development, market
acceptance, operational efficiency, and other factors. In addition, depending on their
future prospects and on market conditions, they may not be able to raise additional funds
when needed or they may receive lower valuations, with less favorable investment terms
than in previous financings, and our investment might become impaired. We will review our
investment quarterly for indicators of impairment. Nevertheless, the impairment analysis
for non-marketable equity investments requires significant judgment to identify events or
circumstances that would significantly harm the value of the investment. The indicators
that we will use to identify those circumstances can include, but are not limited to the
investees revenue and earnings trends; the technological feasibility of the investees
products and technologies; factors related to the investees ability to remain in
business, such as the investees liquidity, debt ratios, and the rate at which the
investee is using its cash; and the investees receipt of additional funding at a lower
valuation. |
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 be included in income
tax expense. In addition, acquired in-process research and development is capitalized as an
intangible asset and amortized over its estimated useful life. The adoption of 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
September 30, 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 or 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 (i.e., 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.
22
SFAS No. 157 establishes a fair value hierarchy that requires an entity to maximize the use of
observable objective inputs and minimize the use of unobservable inputs, which require additional
reliance on our judgment, when measuring fair value. A financial instruments categorization within
the fair value hierarchy is based upon the lowest level of input that is significant to the fair
value measurement. 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. |
We use the following classifications to measure different financial instruments at fair value,
including an indication of the level in the fair value hierarchy in which each instrument is
generally classified:
Cash
equivalents include highly liquid debt investments (money market fund deposits,
commercial paper and treasury bills) with maturities of three months or less at the date of
acquisition. These financial instruments are classified in Level 1 of the fair value hierarchy.
Short-term investments consist of corporate notes and United States government agency
instruments and are classified as available-for-sale. These financial instruments are classified in
Level 1 of the fair value hierarchy. As of September 30, 2008, we had no short-term investments.
Assets that are measured and recognized at fair value on a recurring basis classified under
the appropriate level of the fair value hierarchy as of September 30, 2008 were as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
|
Total |
|
Money market fund deposits |
|
$ |
11,455 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
11,455 |
|
Treasury Bills |
|
|
4,000 |
|
|
|
|
|
|
|
|
|
|
|
4,000 |
|
Commercial papers |
|
|
1,992 |
|
|
|
|
|
|
|
|
|
|
|
1,992 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total: |
|
$ |
17,447 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
17,447 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2008, there are no liabilities that are measured and recognized at fair
value on a recurring basis.
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, 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.
23
Results of Operations
Net Revenue. Summary information by product segment for the three and nine months ended
September 30, 2008 and 2007 is as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
% change |
|
Nine months ended |
|
% change |
|
|
September 30, |
|
period to |
|
September 30, |
|
period to |
|
|
2008 |
|
2007 |
|
period |
|
2008 |
|
2007 |
|
period |
PC Security |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
5,873 |
|
|
$ |
6,140 |
|
|
|
(4 |
)% |
|
$ |
15,758 |
|
|
$ |
17,100 |
|
|
|
(8 |
)% |
Gross profit |
|
|
2,748 |
|
|
|
2,846 |
|
|
|
|
|
|
|
7,172 |
|
|
|
7,345 |
|
|
|
|
|
Gross profit % |
|
|
47 |
% |
|
|
46 |
% |
|
|
|
|
|
|
46 |
% |
|
|
43 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Digital Media Readers |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
520 |
|
|
$ |
1,477 |
|
|
|
(65 |
)% |
|
$ |
3,619 |
|
|
$ |
3,621 |
|
|
|
(0 |
)% |
Gross profit |
|
|
162 |
|
|
|
601 |
|
|
|
|
|
|
|
1,244 |
|
|
|
1,175 |
|
|
|
|
|
Gross profit % |
|
|
31 |
% |
|
|
41 |
% |
|
|
|
|
|
|
34 |
% |
|
|
32 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
$ |
6,393 |
|
|
$ |
7,617 |
|
|
|
(16 |
)% |
|
$ |
19,377 |
|
|
$ |
20,721 |
|
|
|
(6 |
)% |
Gross profit |
|
|
2,910 |
|
|
|
3,447 |
|
|
|
|
|
|
|
8,416 |
|
|
|
8,520 |
|
|
|
|
|
Gross profit % |
|
|
46 |
% |
|
|
45 |
% |
|
|
|
|
|
|
43 |
% |
|
|
41 |
% |
|
|
|
|
Net revenue for the third quarter of 2008 was $6.4 million, down 16% from $7.6 million for the
same period of 2007. The decrease in third quarter revenue year over year was primarily driven by
lower sales of our Digital Media Reader products. For the first nine months of 2008, net revenue
was $19.4 million, down 6% from revenue of $20.7 million for the first nine months of 2007. The
decrease in revenue for the nine months of 2008 compared with the prior-year period resulted
primarily from lower sales of our PC Security products in the first and third quarters of 2008.
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 $5.9 million in the third quarter of 2008, down 4% from
sales of $6.1 million in the third quarter of 2007. Sales levels in the third quarter of 2008 were
relatively unchanged in the U.S., up approximately 20% in Asia and down approximately 20% in
Europe, compared with the third quarter of the prior year. U.S. sales in the third quarter of 2008
increased against U.S. sales in the prior two quarters due to stronger demand for smart card
readers for U.S. government programs. Lower sales in Europe were the result of variability in the
timing of orders and regional programs requiring smart card readers. Higher sales in Asia were the
result of increased sales of smart card interface chips compared with the 2007 period.
For the first nine months of 2008, sales of PC Security products were $15.8 million, down 8%
from sales of $17.1 million for the first nine months of 2007. The decrease in sales in the first
nine months of 2008 compared with the prior year was primarily due to a significant reduction in
sales of our smart card reader products for U.S. government authentication programs in the first
two quarters of 2008, mainly due to project and budget delays. During the first nine months of
2008, we have also experienced an ongoing shift in the U.S. government market away from external
reader devices and towards interface chips that provide embedded reader technology in laptops and
keyboards. We have sold high volumes of smart card interface chips for embedded readers to laptop
and keyboard manufacturers in Asia that have somewhat offset the
decrease in sales of our external reader devices in the U.S.; however, these chips have a lower
average selling price than our external reader devices.
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.
24
Sales of our Digital Media Reader products were $0.5 million in the third quarter of 2008,
down 65% from sales of $1.5 million in the same period of 2007. For the first nine months of 2008,
sales of Digital Media Reader products were $3.6 million, unchanged from sales of $3.6 million for
the first nine months of 2007. During the third quarter of 2008, digital media reader sales were
well below recent quarterly levels due to unexpectedly light orders from a major
customer.
Gross
Profit Margin. Gross profit margin for the third quarter of 2008 was $2.9 million, or 46% of revenue,
compared with $3.4 million, or 45% of revenue in the third quarter of 2007.
Gross
profit margin for our PC Security products was $2.7 million, or 47% of revenue for the third
quarter of 2008, compared with $2.8 million, or 46% for the
third quarter of 2007. Gross profit margin in
the third quarter of 2008 reflects a more favorable mix of products sold compared with the same
period of 2007 as well as ongoing product cost reductions.
Gross
profit margin for our Digital Media Reader products was $0.2 million, or 31% for the third
quarter of 2008, down from $0.6 million, or 41% for the third quarter of 2007. The decrease in
gross profit margin in the third quarter of 2008 compared with the same period of 2007 was primarily due
to lower revenue levels in the 2008 period.
For
the first nine months of 2008, gross profit margin was $8.4 million, or 43% of revenue, compared
with $8.5 million, or 41% of revenue for the first nine months of 2007. The improvement in gross
profit margin in the first nine months of 2008 compared with the prior year primarily is due to a
more favorable mix of higher margin products overall and product cost reductions in our PC Security
business.
We expect there will be some variation in our gross profit from period to period, as our gross
profit has been and will continue to be affected by a variety of factors, including, without
limitation, competition, the volume of sales in any given quarter, product configuration and mix,
the availability of new products, product enhancements, software and services, inventory
write-downs and the cost and availability of components.
Research and Development.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
% change |
|
Nine months ended |
|
% change |
|
|
September 30, |
|
period to |
|
September 30, |
|
period to |
(In thousands) |
|
2008 |
|
2007 |
|
period |
|
2008 |
|
2007 |
|
period |
Expenses |
|
$ |
980 |
|
|
$ |
815 |
|
|
|
20 |
% |
|
$ |
3,058 |
|
|
$ |
2,327 |
|
|
|
31 |
% |
Percentage of total revenues |
|
|
15 |
% |
|
|
11 |
% |
|
|
|
|
|
|
16 |
% |
|
|
11 |
% |
|
|
|
|
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, or 15% of revenue in the third quarter of
2008, up 20% from $0.8 million, which represented 11% of revenue in the third quarter of 2007. For
the first nine months of 2008, research and development expenses were $3.1 million, up 31% from
$2.3 million for the first nine months of 2007. Higher research and development expenses in the
third quarter and first nine months of 2008 compared with the prior year are primarily due to the
development of new contactless PC Security products and 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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
% change |
|
Nine months ended |
|
% change |
|
|
September 30, |
|
period to |
|
September 30, |
|
period to |
(In thousands) |
|
2008 |
|
2007 |
|
period |
|
2008 |
|
2007 |
|
period |
Expenses |
|
$ |
2,280 |
|
|
$ |
1,625 |
|
|
|
40 |
% |
|
$ |
7,010 |
|
|
$ |
4,802 |
|
|
|
46 |
% |
Percentage of total revenues |
|
|
36 |
% |
|
|
21 |
% |
|
|
|
|
|
|
36 |
% |
|
|
23 |
% |
|
|
|
|
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 e-health, contactless
applications and the market business productivity solutions for small and medium-sized businesses.
25
Selling and marketing expenses were $2.3 million, or 36% of revenue in the third quarter of
2008, up 40% from $1.6 million, which represented 21% of revenue in the third quarter of 2007. For
the first nine months of 2008, sales and marketing expenses were $7.0 million, up 46% from $4.8
million in the first nine months of 2007. Higher sales and marketing expenses in the third quarter
and first nine months of 2008 compared with the prior year are primarily due to the hiring of new
sales resources over the past several quarters in Asia, Europe and the Americas 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. Also included in the first nine
months of 2008 are approximately $0.2 million in severance costs recorded in the second quarter of
2008.
General and Administrative.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
% change |
|
Nine months ended |
|
% change |
|
|
September 30, |
|
period to |
|
September 30, |
|
period to |
(In thousands) |
|
2008 |
|
2007 |
|
period |
|
2008 |
|
2007 |
|
period |
Expenses |
|
$ |
1,697 |
|
|
$ |
1,374 |
|
|
|
24 |
% |
|
$ |
4,718 |
|
|
$ |
5,653 |
|
|
|
(17 |
)% |
Percentage of
total revenues |
|
|
27 |
% |
|
|
18 |
% |
|
|
|
|
|
|
24 |
% |
|
|
27 |
% |
|
|
|
|
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.
General and administrative expenses were $1.7 million, or 27% of revenue in the third quarter
of 2008, up 24% from $1.4 million, which represented 18% of revenue in the third quarter of 2007.
Higher general and administrative expenses in the third quarter of 2008 primarily resulted from
increased business development activities related to our strategy to expand and diversify our
customer base and market opportunities. For the first nine months of 2008, general and
administrative expenses were $4.7 million, down 17% from $5.7 million in the first nine months of
2007. General and administrative expense in the first nine months of 2007 included $1.4 million in
severance and other costs associated with the resignation of our former chief executive officer.
General and administrative expenses in the first nine months of 2008 were also impacted by the
devaluation of the dollar against foreign currencies, namely the euro, as we pay the majority of
these expenses in local currency but account for those expenses in dollars. If the trend in recent
weeks continues and the dollar continues to strengthen in relation to foreign currencies, we expect
this impact to be less pronounced in the fourth quarter of 2008.
Amortization of Intangibles. Amortization of intangibles was zero during the third quarter of
2008 and 2007. For the first nine months of 2008, amortization of intangibles was zero, compared
with $0.3 million during the first nine months of 2007.
Interest
and Other Income (Expenses), net. Interest and other income (expenses), net consists
of interest earned on invested cash and foreign currency gains or losses.
In the third quarter of 2008, interest income resulting from invested cash balances was $0.2
million, compared with interest income of $0.4 million for the third quarter of 2007. In the first
nine months of 2008, interest income was $0.6 million, compared with interest income of $1.2
million in the first nine months of 2007. The reduction in interest income reflects our reduced
cash balance and the reduction in interest rates in 2008 compared to 2007.
Foreign currency losses were $1.3 million in the third quarter of 2008 compared with $0.1
million in the third quarter of 2007. Foreign currency losses were $0.9 million in the first nine
months of 2008 compared with $0.2 million for the first nine months of 2007. Our foreign currency
losses primarily result from the valuation of current assets and liabilities denominated in a
currency other than the functional currency of the respective entity in the local financial
statements. Accordingly, these foreign currency losses are predominantly non-cash items. Higher
foreign exchange losses in the third quarter of 2008 are primarily the result of the weakening of
the euro versus the U.S. dollar, as measured at the end of the quarter. If the euro remains weak
relative to the U.S. dollar for the next several weeks, we expect that we will record further
losses on foreign currency exchange in the fourth quarter of 2008.
Income
Taxes. In the three and nine months ended September 30, 2008, we recorded a provision for
income taxes of $0.1 million and $0.2 million, respectively, primarily for minimum taxation, which
could not be offset with operating loss carryforwards and tax expenses in a foreign subsidiary with
no loss carryforwards.
26
In the three and nine months ended September 30, 2007, we recorded a provision for income
taxes of $32,000 and $0.1 million, respectively, primarily for minimum taxation, which could not be
offset with operating loss carryforwards and tax expenses in a foreign subsidiary with no loss
carryforwards.
Discontinued Operations. On May 22, 2006, we completed the sale of substantially all the
assets and some of the liabilities associated with our DTV solutions business to Kudelski S.A. Net
revenue for the DTV solutions business in both the three and nine months ended September 30, 2008
was zero. Net revenue for the DTV solutions business in the three and nine months ended September
30, 2007 was zero and $0.5 million, respectively. Operating gain for the DTV solutions business in
the three and nine months ended September 30, 2008 was $32,000 and $26,000, respectively. Operating
loss for the DTV solutions business for the three and nine months ended September 30, 2007 was
$45,000 and $33,000, respectively.
In May 2007, we received a final payment of $1.6 million from Kudelski related to the sale of
our DTV solutions business that resulted in a $1.5 million gain on sale of discontinued operations
in the first quarter of 2007 (See Note 3 to Condensed Consolidated Financial Statements). During
the three and nine months ended September 30, 2007, net gain on the disposal of discontinued
operations was approximately $16,000 and $1.6 million, respectively.
During 2003, we completed two transactions to sell our retail Digital Media and Video
business. On July 25, 2003, we completed the sale of our digital video business to Pinnacle Systems
and on August 1, 2003, we completed the sale of our retail digital media reader business to Zio
Corporation. Net revenue for the retail Digital Media and Video business was zero in each of the
three and nine months ended September 30, 2008 and 2007. Operating loss for the retail Digital
Media and Video business in the three and nine months ended September 30, 2008 was $0.1 million and
$0.2 million, respectively. Operating loss for the retail Digital Media and Video business was $0.1
million and $0.2 million in the three and nine months ended September 30, 2007, respectively.
In April 2008, we entered into an agreement to terminate our lease agreement for premises
leased in the UK, which resulted in approximately $0.4 million in gain on sale of discontinued
operations. During the three and nine months ended September 30, 2008, the total net gain on the
disposal of discontinued operations was approximately $44,000 and $0.6 million, respectively.
Liquidity and Capital Resources
As of September 30, 2008, our working capital, which we have defined as current assets less
current liabilities, was $27.8 million, compared to $34.0 million as of December 31, 2007, a
decrease of approximately $6.2 million. The reduction in working capital for the first nine months
of 2008 primarily reflects a reduction of cash and cash equivalents and short-term investments of
$7.4 million and a combined decrease in accounts receivable, inventories and other current assets
of $0.8 million. The reduction in other current assets was partly offset by a $2.0 million decrease
in current liabilities.
Cash and cash equivalents and short-term investments were $25.0 million as of September 30,
2008, a decrease of approximately $7.4 million compared to $32.4 million as of December 31, 2007.
Short-term investments were zero at September 30, 2008, compared to $13.8 million at December 31,
2007. The reduction in short-term investments is the result
of our decision in late 2007 to move liquidity resources into more highly liquid debt
investments (money market fund deposits, commercial paper and treasury bills) with maturities of
three months or less at the date of acquisition.
The following summarizes our cash flows for the nine months ended September 30, 2008 (in
thousands):
|
|
|
|
|
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
|
2008 |
|
Operating cash used in continuing operations |
|
$ |
(6,555 |
) |
Operating cash used in discontinued operations |
|
|
(350 |
) |
Investing cash provided |
|
|
13,339 |
|
Financing cash flow |
|
|
18 |
|
Effect of exchange rate changes on cash and cash equivalents |
|
|
(32 |
) |
|
|
|
|
|
|
|
|
|
Increase in cash and cash equivalents |
|
|
6,420 |
|
Cash and cash equivalents at beginning of period |
|
|
18,600 |
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
25,020 |
|
|
|
|
|
27
During the first nine months of 2008, cash used in operating activities was $6.9 million. This
use of cash consisted of a net loss of approximately $6.0 million, the use of approximately $0.2
million from net changes in operating assets and liabilities and the use of approximately $1.2
million from the net changes in the assets and liabilities from discontinued operations. This
effect was partially offset by positive cash flow adjustments for depreciation, amortization and
stock compensation totaling $0.5 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 $4.6 million at September 30,
2008. As of September 30, 2008, inventory and other purchase commitments due within one year were
approximately $10.1 million and additional inventory and other purchase commitments due within two
years were approximately $2.6 million.
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 2009. We may,
however, seek additional debt or equity financing prior to that time. There can be no assurance
that additional capital will be available to us on favorable terms or at all. The sale of
additional debt or equity securities may cause dilution to existing stockholders.
Cash provided from investing activities of $13.3 million for the nine months ended September
30, 2008 was primarily from the maturity of short-term investments, which was partly offset by
capital expenditures of $0.5 million.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no significant change in our exposure to market risk during the three months
ended September 30, 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
Attached as exhibits to this Form 10-Q are certifications of our Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), which are required in accordance with Rule 13a-14 of
the Securities Exchange Act of 1934, as amended (the Exchange Act). This Controls and
Procedures section includes information concerning the controls and controls evaluation referred
to in the certifications.
(a) Evaluation of Disclosure Controls and Procedures
As of September 30, 2008, SCM carried out an evaluation, as required in Rule 13a-15(b) under
the Exchange Act, under the supervision and with the participation of our management, including our
CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and
procedures, as defined in Rule 13a-15(e) under the Exchange Act. Based on this evaluation, our CEO
and CFO concluded that, as of September 30, 2008, our disclosure controls and procedures were
effective to provide reasonable assurance that the information required to be disclosed in our
Securities and Exchange Commission (SEC) reports that we file or furnish under the Exchange Act
(i) is recorded, processed, summarized and reported within the time periods specified in SEC rules
and forms, and (ii) is accumulated and communicated to our management, including our CEO and CFO,
as appropriate to allow timely decisions regarding required disclosure. In the course of this
evaluation, we sought to identify any significant deficiencies or material weaknesses in our
disclosure controls and procedures, to determine whether we had identified any acts of fraud
involving personnel who have a significant role in our disclosure controls and procedures, and to
confirm that any necessary corrective action, including process improvements, was taken. The
overall goals of these evaluation activities are to monitor our disclosure controls and procedures
and to make modifications as necessary. We intend to maintain these disclosure controls and
procedures, modifying them as circumstances warrant.
(b) Changes in Internal Controls over Financial Reporting
In connection with our continued monitoring and maintenance of our controls procedures as part
of the implementation of section 404 of the Sarbanes-Oxley Act of 2002, we continue to review,
revise and improve the effectiveness of our internal controls. We made no changes to our internal
control over financial reporting during the third quarter of 2008 that have materially affected, or
that are reasonably likely to materially affect, our internal control over financial reporting.
28
(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
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 $198.1 million as of September 30,
2008. 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 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; |
29
|
|
|
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; |
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the sales volume, product configuration and mix of products that we sell; |
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technological changes in the markets for our products; |
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the rate of adoption of industry-wide standards; |
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reductions in the average selling prices that we are able to charge due to
competition or other factors; |
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strategic acquisitions, sales and dispositions; |
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fluctuations in the value of foreign currencies against the U.S. dollar; |
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the timing and amount of marketing and research and development expenditures; |
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loss of key personnel; and |
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costs related to events such as dispositions, organizational restructuring, headcount
reductions, litigation or write-off of investments. |
Due to these and other factors, our revenues may decrease from their current levels. Because a
majority of our operating expenses are fixed, a small variation in our revenues can cause
significant variations in our operational results from quarter to quarter and our operating results
may vary significantly in future periods. Therefore, our historical results may not be a reliable
indicator of our future performance.
Disruption in the global financial markets may adversely impact the availability and cost of
credit.
Our ability to obtain financing for acquisitions or other general corporate and commercial
purposes depends on our operating and financial performance and is also subject to prevailing
economic conditions and to financial, business and other factors beyond our control. Recently,
global credit markets and the financial services industry have been experiencing a period of
unprecedented turmoil characterized by the bankruptcy, failure or sale of various financial
institutions. As a result, an unprecedented level of intervention from the United States and other
governments has been seen. As a result of such disruption, our ability to raise capital may be severely
restricted and the cost of raising capital through such markets or privately may increase
significantly at a time when we would like, or need, to do so. Either of these events could have
an impact on our flexibility to pursue additional expansion or acquisition opportunities, make
capital expenditures, or make another discretionary use of cash and could adversely impact our
financial results. In any case, there can be no assurance that such funds, if available at all,
can be obtained on terms reasonable to us.
Disruption in the global financial markets may adversely impact our customers and customer
spending patterns.
In addition, the current financial crisis may cause consumers, businesses and governments to
defer purchases in response to tighter credit, decreased cash availability and declining consumer
confidence. Accordingly, demand for our products could decrease and differ materially from our
current expectations. Further, some of our customers may require substantial financing in order to
fund their operations and make purchases from us. The inability of these customers to obtain
sufficient credit to finance purchases of our products and meet their payment obligations to us
could result in decreased customer demand, an impaired ability for us to collect on outstanding
accounts receivable, significant delays in accounts receivable payments, and significant write-offs
of accounts receivable, each of which could adversely impact our financial results. In addition, if
the financial crisis results in insolvencies for our customers, it could adversely impact our
financial results.
30
Disruption in the global financial markets may adversely impact our suppliers.
Our ability to meet customers demands depends, in part, on our ability to obtain timely and
adequate delivery of quality materials, parts and components or products from our suppliers.
Certain of our components are available only from a single source or limited sources. If certain
key suppliers were to become capacity constrained or insolvent as a result of the financial crisis,
it could result in a reduction or interruption in supplies or a significant increase in the price
of supplies, each of which would adversely impact our financial results. In addition, credit
constraints at key suppliers could result in accelerated payment of accounts payable by us,
impacting our cash flow.
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 most of the trading of our stock is 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:
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low volumes of trading activity in our stock, particular in the U.S.; |
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variations in our or our competitors financial and/or operational results; |
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the fluctuation in market value of comparable companies in any of our markets; |
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expected, perceived or announced relationships or transactions with third parties; |
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comments and forecasts by securities analysts; |
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trading patterns of our stock on the NASDAQ Stock Market or Prime Standard of the
Frankfurt Stock Exchange; |
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the inclusion or removal of our stock from market indices, such as groups of
technology stocks or other indices; |
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loss of key personnel; |
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announcements of technological innovations or new products by us or our competitors; |
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announcements of dispositions, organizational restructuring, headcount reductions,
litigation or write-off of investments; |
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litigation developments; and |
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general market downturns. |
In the past, companies that have experienced volatility in the market price of their stock
have been the object of securities class action litigation. If we were the object of securities
class action litigation, it could result in substantial costs and a diversion of our managements
attention and resources.
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, the financial sector
and corporate enterprises. Sales to a relatively small number of customers historically have
accounted for a significant percentage of our revenues. Sales to our top ten customers accounted
for approximately 56% of revenue in the first nine 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 third quarter of 2008, sales of our digital media readers
were significantly lower than in previous quarters due to variability in the timing of orders from
one large 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, recently we have added sales
resources to target authentication programs in the government and enterprise sectors in Latin
America and Asia, and have 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. We recently introduced the first of these
products in October 2008. Because the markets for our products are still emerging, demand for our
products is subject to variability from period to period. There is no assurance that demand will
become more predictable as additional smart card programs demonstrate success. 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, for example the economic uncertainty caused by the
current global banking crisis; |
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our ability to demonstrate to our potential customers and partners the value and
benefits of new products; |
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the ability of our competitors to develop and market competitive solutions for
emerging applications in our target markets and our ability to win business in advance of
and against such competition; |
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the adoption and/or continuation of industry or government regulations or policies
requiring the use of products such as our smart card readers; |
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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. |
A significant portion of our revenue is dependent upon sales to 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.
Large government programs are a primary target for our PC Security business, as smart card
technology is increasingly used to enable applications ranging from paying taxes online, to citizen
identification, to receiving health care. Historically, we have sold a significant proportion of
our PC Security products to the U.S. government for PC and network access by military and federal
employees, and these sales have been an important component of our overall revenue. In recent
periods, we have experienced a significant decrease in sales of our external smart card readers to
the U.S. government, primarily due to weaker demand in this market as a result of ongoing project
and budget delays and a movement by the U.S. government towards purchasing computer equipment with
embedded reader capabilities. We continue to believe that we remain a leading supplier of smart
card reader technology to the U.S. government market and that we are not losing share to
competitors. However, lower overall market demand and the replacement of external smart card reader
sales with sales of lower-priced interface chips for embedded readers have resulted in reduced
revenue from the U.S. government sector, which we believe is not likely to consistently return to
previous levels. We anticipate that a significant portion of our future revenues will come from
government programs outside the U.S., such as national identity, e-government, e-health and others
applications. We currently supply smart card readers for various government programs in Europe and
Asia and are actively targeting additional programs in these areas as well as in Latin America. We
have also spent significant resources developing a range of e-health smart card terminals for the
German governments electronic healthcard program. However, the timing of government smart card
programs is not always certain and delays in program implementation are common. For example, while
the German government has stated that it plans to distribute new electronic health cards to its
citizens beginning in late 2008 and to have in place a corresponding network and card reader
infrastructure by 2009, there have already been delays in this program and the actual timing of
equipment and card deployments in the German e-health program remain uncertain. The continued delay
of government projects for any reason could negatively impact our sales.
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.
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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.
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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 third-party 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
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 or market in conjunction with our products, technology or distribution capabilities.
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.
Additionally, 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.
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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. 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.
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. In
addition, certain actions, including the approval of a significant transaction, may require
approval of a majority of the total number of our shares then outstanding. 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
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. If we are
unable to achieve a quorum or the required approval of a matter 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 also 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.
One of our directors is a partner in the largest shareholder of our Company, and both of them have
significant influence over the outcome of corporate actions requiring board and shareholder
approval, respectively; however the shareholders priorities for our business may be different
from the Companys or our other shareholders.
As of September 30, 2008, Lincoln Vale European Partners (Lincoln Vale) holds nearly 10% of
the outstanding shares of our common stock. Dr. Hans Liebler, one of our directors, is a partner of
Lincoln Vale and may also be deemed to beneficially own, either directly or indirectly through
limited partnerships, the shares invested by Lincoln Vale in our Company. Accordingly, Dr. Liebler
and/or Lincoln Vale could have significant influence over the outcome of corporate actions
requiring board and shareholder approval, respectively, including the election of directors, any
merger, consolidation or sale of all or substantially all of our assets or any other significant
corporate transaction. In addition, Dr. Liebler and/or Lincoln Vale could delay or prevent a change
of control of our company, even if such a change of control would benefit our other shareholders.
We cannot assure you that Lincoln Vales objectives are aligned with those of the other
shareholders.
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.
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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 63% of our revenue for the nine months
ended September 30, 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 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 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, excluding a one-time severance payment made to our former chief executive officer in the
second quarter of 2007, our general and administrative expenses in the first half 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. In addition, the valuation of current assets and liabilities that are
denominated in a currency other than the functional currency can result in currency exchange gains
and losses. For example when an SCM subsidiary has the
38
euro as the functional currency, and this subsidiary has a receivable in U.S. dollars, a
devaluation of the U.S. dollar against the euro of 10% would result in a foreign exchange loss of
the reporting entity of 10% of the value of the underlying U.S. dollar receivable. 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. In
particular, our current strategy to penetrate the market for contactless payment solutions is
heavily dependent on the vision, leadership and experience of our chief executive officer, Felix
Marx.
We also believe that our future success will depend in large part on our ability to attract
and retain highly qualified technical and management personnel. However, competition for such
personnel is intense. We may not be able to retain our key technical and management employees or to
attract, assimilate or retain other highly qualified technical and management personnel in the
future.
Likewise, as a small, dual-traded company, we are challenged to identify, attract and retain
experienced professionals with diverse skills and backgrounds who are qualified and willing to
serve on our Board of Directors. The increased burden of regulatory compliance under the
Sarbanes-Oxley Act of 2002 creates additional liability and exposure for directors and financial
losses in our business and lack of growth in our stock price make it difficult for us to offer
attractive director compensation packages. If we are not able to attract and retain qualified board
members, our ability to practice a high level of corporate governance could be impaired.
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 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
39
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.
Changes to financial accounting standards may affect our results of operations and cause us to
change our business practices.
We prepare our financial statements to conform with U.S. GAAP. These accounting principles are
subject to interpretation by the Financial Standards Accounting Board, the American Institute of
Certified Public Accountants, the Securities and Exchange Commission and various other bodies
formed to interpret and create appropriate accounting rules and policies. A change in those rules
or policies could have a significant effect on our reported results and may affect our reporting of
transactions completed before a change is announced. Any changes in accounting rules or policies in
the future may result in significant accounting charges.
We face costs and risks associated with maintaining effective internal controls over financial
reporting, and if we fail to achieve and maintain adequate internal controls over financial
reporting, our business, results of operations and financial condition, and investors confidence
in us could be materially affected.
Under Sections 302 and 404 of the Sarbanes-Oxley Act of 2002, our management is required to
make certain assessments and certifications regarding our disclosure controls and internal controls
over financial reporting. We have dedicated, and expect to continue to dedicate, significant
management, financial and other resources in connection with our compliance with Section 404 of the
Sarbanes-Oxley Act. The process of maintaining and evaluating the effectiveness of these controls
is expensive, time-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.
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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 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 continue to
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. Beginning in the third quarter of 2008, global
economic uncertainty has resulted in slower collections for us with some customers.
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.
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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 November 3, 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
September 30, 2008, an aggregate of approximately 3.1 million shares of common stock was reserved
for future issuance under our stock option plans, of which 1.9 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.
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.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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Registrant |
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SCM MICROSYSTEMS, INC. |
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November 10, 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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November 10, 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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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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10.1(4)
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Code of Conduct and Ethics revised October 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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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 October 28, 2008 (see SEC File
No. 000-29440). |
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